Nike: Single Stock Risk and When to Diversify

Monday, April 8, 2019

nike concentrated stock position

By Steven Hanks, CFP®

Like many large companies, Nike offers its employees multiple avenues to acquire its stock either at a discount or as a part of a compensation plan.

We have seen a large infusion of wealth in the greater Portland metro area due to the performance of Nike stock over the last decade. While it has been a fantastic growth driver for the city and many employees’ balance sheets, holding a concentrated stock position may not be the optimal approach to preserve and grow your wealth.

In order to come up with a plan to diversify across the investment universe, we first need to define what concentration is and the risks associated with putting most of your eggs in one basket.

What is a Concentrated Stock Position?

As the name implies, a concentrated stock position is an undiversified holding that maintains a substantial allocation in an investment portfolio. Some investors tie it to a certain percentage of your overall allocation, but applying an arbitrary percentage isn’t the best way to frame the conversation.

The right way to think about it is whether your plan is still successful if the stock price in question goes to zero. While this is a highly unlikely scenario, it is a real risk associated with all individual stock investments.

Why Relying on One Stock is Risky

Risk can fall into two major categories: market risk and idiosyncratic risk.

Market risk is the risk associated with investing in capital markets that can’t be diversified away. Investors generally accept the risk of a broad market pullback, as long as they are compensated in the long term with a reasonable rate of return.

Idiosyncratic risk is much different. Variation in stock price due to missed earnings, downward guidance, or C-level executive turnover are examples of idiosyncratic risks. They are very specific to a single company and will have very little if any influence on the broader market.

Idiosyncratic risks can be exacerbated for employees of a company whose stock makes up a substantial portion of their portfolio. Not only is the portfolio performance tied to the company stock, but we may also see wage and benefit reductions as the company tightens its belt during economic downturns. Simultaneous declines in earning potential and investments can take a serious toll on a financial plan.

If we know that idiosyncratic risk is generally uncompensated over long periods of time, why doesn’t everyone just diversify and take what the market gives them? There are a few hurdles that investors need to overcome.

Is Diversification More Profitable?

Diversification is the go-to method for reducing investment risk while offering a rate of return that will afford the average investor the opportunity for a great retirement.

However, there’s always some degree of risk associated with investing. For investors who have built their wealth betting on a few select companies, we find a few different reasons behind the lack of diversification.

Volatility is a major concern when planning for future cash needs. Investors can ignore the noise with a long-term viewpoint and proper planning.

For some, the tax impact associated with selling and redeploying stock proceeds keeps them from taking action. While after-tax returns are very important, any taxes avoided by not selling can be quickly eaten up by a quarter or two of poor earnings or guidance.

For others, the hurdle is psychological. Why would you divest from the company that provided all those great returns over the years?

The Benefits of Diversification

Diversification presents three unique benefits that single company stock can’t compete with: reducing volatility, protecting assets, and generating a smoother return stream.

When one stock performs poorly, your other stocks may perform better during the same timeframe so that you continue generating returns. This helps reduce your overall losses and makes you less reliant on a single source of investment income. Better yet, you could take the selection process out of it and buy the entire stock market with a low-cost ETF or mutual fund for any long-term dollars.

In addition, diversification can help you protect the gains you’ve made. If you’re close to retirement, you’ll want to focus on preserving your capital by reducing the impact of volatility on your investments by anticipating your future cash needs.

How to Pursue a Diversification Strategy

From a general investment standpoint, do you have the proper allocation given your cash needs from the portfolio? Can your long-term financial plan survive a significant downturn in the price of Nike stock? Or, on the flip-side, would your plan work if you divested and paid any applicable federal or state taxes?

Volatility is a major concern when planning for future cash needs. With a thoughtful approach, an investor can ignore the noise with a long-term viewpoint and proper planning.

It has been proven again and again that trying to time the market is a fool’s errand. Working with a team of professionals to plan for your future is the ideal way to separate yourself from the pack—and separation is in the preparation.

Brighton Jones is offering Nike employees a consultation on diversification strategies to help you grow your wealth. Reach out to us today to start planning for your financial future.

Steven Hanks, CFP® serves as an advisor at Brighton Jones.

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