How Much Is Too Much In One Basket?
How much is too much? This question comes up all the time with my clients. Let’s see if you can relate.
You’ve been asked by a friend to invest in a real estate flip. You agree to put in $50,000, and you double your money in 6 months! Your friend now wants to do another flip, but you will need to put in $200,000 this time. Greater risk, but possibly even greater reward. Is $200,000 too much?
You receive an inheritance from your father passing away. He worked for IBM his whole life and most of the inheritance is shares of IBM stock. You wonder if you should sell some of it, but your dad always told you how good the stock was and that you should hold it forever.
You receive stock options from your employer. If you were able to exercise all of them today it would be a substantial amount of money. However you think the stock price will continue to go up so you are conflicted on if you should sell or hold these options.
You’ve been given the opportunity to buy ownership in your company. It’s a big investment, but you believe in the future growth of the company. How much is too much to invest there right now?
These are all situations I have worked through recently with clients. Since it seems to come up again and again, I want to share how I like to think about it.
Diversification
Every good financial advisor will talk to you about diversification. There are two schools of thought.
- Don’t put all your eggs in one basket. Diversify so that if any one investment fails, you don’t lose everything.
- Put all your eggs in one basket, and watch that basket very closely (sometimes quoted by the wealthiest businessmen).
I ascribe more to the first philosophy. To use a baseball analogy, I would win the game by hitting lots of singles instead of swinging for the fences every pitch. And then when I had a substantial lead, I would start taking more risk.
The best way to consider the above situations is to think about perspective. Real estate, individual stocks, stock options, and company ownership are all part of your investment portfolio. And they are all concentrated investments. If there is any risk that one investment failing could ruin your financial life, then you have too much in that investment.
I approach this by calculating the percentage that the concentrated investment totals in my whole investment portfolio. Maybe you inherited $400,000 of IBM stock and your other investment accounts total $400,000. You now have $800,000 invested, but the IBM stock makes up 50% of your investment portfolio. I don’t know many people who would be okay betting 50% of their portfolio on a single stock.
The ideal number is 5%. If a single investment makes up more than 5% of your investment portfolio then you need to diversify it.
Of course other factors come into play. There can be an emotional attachment to an investment. You could face a big tax bill if you sell. You might face an awkward conversation with your friend or your boss.
This is why it is important to have a confidant who you can discuss these decisions with. I love working with clients on this! I enjoy hearing my clients’ hearts and thoughts on their investments and helping them consider the emotional side as well as the practical side. I gather the pieces and present the facts so my clients can make an informed decision with all the relevant details in front of them.
If you’re taking a second look at your portfolio or struggling with a situation like this, reach out to me! I’d love to help!
