Ask yourself the following:
“Am I confident that ABC stock will outperform the S&P 500 over the next 10 to 20 years?”
“If I did not own ABC stock and had cash to invest, would I invest in ABC stock today?”
If either answer is no, you should ask yourself “why am I holding this stock”
I have had clients that have held over 20% of their wealth in an individual stock just because: they worked for the company, it has done well, it was inherited, “mom made a lot of money on ABC stock.”
Keep in mind that the history of public companies (those who issue stocks) is one filled with once great companies that have declined or gone out of business – click on the chart above for an interesting perspective.
An individual stock can go down and never return to its current high (see picture above), while the stock market has always gone up. Therefore, the downside risk of an individual stock is the risk of total loss. Whereas, the worse case scenario of selling an individual stock and buying an S&P 500 fund would be that the individual stock outperforms the S&P 500 over time. A low chance of that happening.
In these situations, investors exhibit a few classic biases common to behavioral finance:
- Recency bias – investors think that what happened in the past will keep happening.
- Endowment effect – once we own something, we value it at a higher amount than if we were to buy it new.
- The tax effect – investors don’t want to sell because they would have to pay capital gains tax. So when do you sell? When the stock declines? Don’t let paying tax drive good investment decisions. Unless, you plan on leaving an appreciated stock to your heirs (inherited gains are wiped away when inherited), the tax will have to be paid eventually.
NOTE: This is not meant to be specific investment advice. Any investment move should be coordinated with an objective advisor who can help you decide whether the transaction works with your plan.