How to Manage Stock Concentration Risk

Too much can definitely be a bad thing when it comes to particular stocks.

Concentration risk is when any single asset—or group of assets—comes to dominate the value of your portfolio. This can work in your favor when that asset is having a hot run. But should it falter, especially when you're focused on preserving your savings, the effect on your portfolio could be catastrophic.

Concentration risks can creep into a portfolio several ways. For example, you might acquire a large position in a single stock through equity compensation or an employee stock purchase plan. You could also find yourself overly exposed to certain mega-cap stocks via investments that track market cap-weighted indexes like the S&P 500^® Index.

How do you know when your concentration risks are mounting? In general, if a single stock accounts for more than 10% of your investment portfolio (or more than 20% if you are restricted from selling), your portfolio may be overly concentrated.

The next question becomes what to do about it. We suggest starting with a plan, in three steps:

1. Define your individual needs. On your own, or working with a professional advisor, understand your wealth and the role the concentrated position plays in your holistic financial picture.
2. Determine your objectives. Identify your priorities and the best path forward.
3. Develop strategic plan. Connect your objectives to the best solutions and actions for you.

In general, you have three options when determining your objectives: keep the stock but help protect against losses or generate income; sell the stock to unlock liquidity and/or diversify; or give the stock away to help build a legacy. You don't need to choose just one. A combination of all three may be a tax-efficient way to help achieve your goals.

You may have reasons for keeping a stock that dominates your portfolio. First, you may not have a choice: If the stock is part of your compensation package, sales might be restricted for a set period. Another common situation is to have a single stock appear in many different funds—particularly market capitalization-weighted funds that give a larger allocation to the market's biggest companies—which can lead a person who has invested in funds to inadvertently overinvest in a handful of stocks.

Whatever the case, if you're planning to keep your position, you could consider some ways to manage your risk and/or generate income to potentially offset any losses.

A stop order is an order to sell (or buy) a stock at the market price once the stock has traded at or through a specified price (the "stop"), which can help you manage the risk of prolonged slump in your concentrated shares.

In most cases, your stock will sell for close to the market price when a stop order is triggered. However, in cases where the stock is dropping rapidly, the stock is halted and reopens for trading, or when the stock gaps down in the morning (lower than the prior day's closing price), your execution price could be significantly lower than your stop price. Keep in mind, too, that such sales could trigger taxes and keep you from participating in future rallies.

This is a different kind of risk-management strategy. When you buy a put option, you pay a cost called a premium in exchange for a contract that allows you to sell 100 shares (typically) of stock on or before a chosen date at a predetermined price (the "strike price"). If the price of the underlying stock drops significantly, that put option contract will likely rise in value. This could at least partially offset the losses in the underlying stock's value. You can usually sell a protective put at any time (assuming the market is open, and sufficient liquidity in your option) until the contract expires.

Note that options prices are volatile and options contracts tend to lose value over time. This time decay may not be obvious if the underlying stock and the options price swing aggressively. However, if the underlying stock isn't moving quickly, the option you bought will likely decline in value. If the stock doesn't end up falling sharply, a protective put will likely cost you a substantial amount of money in the form of the premium you paid. In other words, unless the underlying stock is dropping, there may be considerable costs to holding on to protective puts. Company stock rules may also forbid employees from using options strategies.

This is a more complex strategy in which you buy a protective put but then offset the cost of the premium by selling a call option, which gives you the right to buy a stock at a predetermined price. With this strategy, the put can help you set a floor for potential losses at the desired strike price. Losses below the strike price are offset by the right to sell the stock at the strike price. This strategy also creates a ceiling, though, as gains are limited to the strike price of the call. Any appreciation above the strike price may be lost.

You should also be aware that a covered call could theoretically be assigned before you have the chance to close it out or roll out to the next expiration. Should this happen, you would lose your stock position and could face tax consequences. Keep in mind that creating a collar is a potentially disclosable event for corporate insiders and controlling shareholders. Company stock rules may also forbid employees from using options strategies.

Direct indexing involves buying most (if not all) of the individual stocks that make up an index, and then adding to, subtracting from, or reweighting its components, depending on your investment strategy and tax goals. In this way, you could potentially avoid shares to which you are already heavily exposed, thereby diversifying without exacerbating your concentration risks.

By holding shares of individual companies in an index, you may also take advantage of opportunities to recognize capital losses (known as tax-loss harvesting). Those losses can be used to offset any gain realized from selling a concentrated position.

Selling some of your shares and potentially reinvesting the proceeds in a more diversified selection of assets is one of the simplest ways to reduce your concentration risk.

One common concern is taxes, especially if the position's cost basis is extremely low. Selling a large, appreciated position all at once can potentially result in a large tax bill.

If your stock is in a taxable brokerage account, sales could be taxed at either short-term (if the stock is held for a year or less) or long-term (if held longer than a year) capital gains rates. Tax-efficient strategies, such as harvesting losses or strategically managing your cost basis options can help. (Recall that Schwab doesn't provide tax advice. Investors should consult a professional tax advisor for specific tax advice.)

Of course, if the stock is in a tax-advantaged account, such as a 401(k) or IRA, this might not be as much of an issue because selling within these accounts won't result in current taxes. Taxes are due only when you make withdrawals from the account. Note: Before selling any employer stock in your 401(k) or potentially rolling it over into your IRA, consider your eligibility for Net Unrealized Appreciation (NUA) tax treatment.

In any case, you don't have to sell it all at once or even in a single year. If you're an executive or entrepreneur, you may not even be able to do so due to restrictions on stock sales by insiders.

One solution would be to create a multi-year sales plan, with a tax budget. This can be done either by collaborating with an advisor, or through certain managed investment strategies, where an asset manager or advisor could help you transition to a more diversified portfolio.

A more formal approach would be to adopt a 10b5-1 trading plan. These plans are used by executives as an affirmative defense against insider trading (seek the help of your stock plan administrator, company legal counsel, and personal financial and tax advisor if this applies to you).

Taking an incremental approach may also allow you to capture more gains if the assets to which you're heavily exposed keep appreciating. That could help assuage any seller's remorse you might otherwise feel, though it also means your concentrated position will take longer to unwind, potentially leaving you exposed to unfavorable market fluctuations.

If your wealth management goals include donating to charity or transferring wealth to the next generation, using highly appreciated stock to do so could reduce your concentration risk and offer potential tax advantages.

Donating highly appreciated stock to charity generally makes more sense than selling the position and donating the proceeds, because you can avoid paying capital gains tax and potentially receive a tax deduction equal to the fair market value of the donated shares. But be aware, donation deductions are subject to adjusted gross income (AGI) limitations, such as the new 0.5% floor and 30% of AGI limit). You can gift stock directly to a charity or use charitable strategies, such as a donor-advised fund or a charitable remainder trust.

Or you might consider gifting the appreciated stock to a family member—maybe that new graduate—particularly if they are in a lower tax bracket than you. Not only will you avoid capital gains tax, but you could also remove the future potential appreciation from your estate. You can gift up to $19,000 per recipient in 2026 ($38,000 for a married couple) without eating into your lifetime gift and estate tax exemption. Or you could use a portion of your $15 million gift and estate tax exemption to pass on the assets tax free.

A portfolio with concentrated stock should be managed carefully. Strategies do not have to be all-or-nothing but could be used in combination and structured in line your unique situation, preferences, and concerns.

Whatever path you take, having a step-by-step framework, to both help protect and unlock value from concentrated positions, can help you protect your wealth.