Conventional investing wisdom tells us that one key to mitigating market risk is maintaining a well-diversified portfolio — that is, a strategic mix of stocks and bonds that span different industries and includes exposure to both domestic and international markets. A concentration of value in one stock (as can occur with a low-cost stock holding) can upset portfolio diversification and in turn, increase exposure to risk. It’s akin to putting your proverbial eggs in one basket.
How can you mitigate the potential risk from a low-cost holding? At Cambridge Trust Wealth Management, it comes down to three steps.
The first step of managing a low-cost stock holding is to understand its size in relation to your total assets; this will help determine if your portfolio requires rebalancing. Next, consider any tax implications. Low-cost stock holdings are synonymous with a big profit, and the bigger your profit, the more you can lose to capital gains taxes. Finally, it’s critical to consider your investing goals and constraints. These include your risk tolerance, time horizon, and income needs as well as any unusual or large upcoming expenses.
While a low-cost holding might be performing well at the moment, that doesn’t mean it always will. An investment manager can conduct an analysis of the company to determine how it might perform in the future. Is the company well-established? What is the track record of the company’s management? Is the company diversified both geographically and by lines of business? How competitive is its industry? Do new technological trends threaten obsolescence? Another important consideration is the stock’s valuation in relation to its long-term earning prospects. All of these factors help determine how quickly to sell, how much to sell, or if it’s even right to sell at all.
Holders of low-cost stock have a number of strategies available to them. They can make an outright sale that is timed to minimize the tax impact. They can use the stock to make a charitable gift, thereby avoiding capital gains taxes while gaining a charitable tax deduction. Another strategy for low-cost holdings is to adjust other stocks in a portfolio so as to lessen concentration in a single industry. Under certain circumstances, it may be prudent to take minimal action with a low-cost holding. This may be the case when a low-cost holding is a well-established business, with sound financial characteristics, that is highly diversified and the stock trades at a reasonable valuation. This latter course of action is particularly appropriate for dividend-paying stocks where income may be an important consideration.
Low-cost stock holdings can come about for a variety of reasons. Frequently, low-cost securities are inherited from a parent or grandparent. Sometimes, low-cost holdings arise from a business venture. Plain good fortune can also play a role. Often, what started out as a small flyer in a portfolio can grow in value over time.
However you find yourself with a low-cost stock holding, it’s important to evaluate the holding on its own merits and in relation to your overall financial circumstances. A Cambridge Trust investment officer can help you weigh all the personal and financial factors to determine the most favorable course of action for you.
This article is for informational purposes only and should not be construed as investment or legal advice.