Concentrated stock positions: High rewards, higher risks – What to know before betting big on one stock

Executive summary:

• Many investors believe that holding “the next big thing” is the route to outsized gains in the stock market
• But the risks may be high, and knowing when to divest is key as market leadership does tend to change – sometimes suddenly
• Help your clients avoid “single-stock risk” through diversification.

The recent dominance of the “Magnificent 7” technology names may help fuel the common belief that a single stock portfolio is the best way to deliver extraordinary returns. But looking back over a longer-term horizon, a concentrated stock portfolio has often led to greater volatility and potential losses. While holding a big chunk of a portfolio in one specific name can offer the potential for outsized gains, it can also expose investors to significant risks.

Active investing vs. overconcentration

A concentrated stock position is generally defined as holding more than 10% of a portfolio in a single stock. Having a large position in a single stock might seem a good way to achieve benchmark-beating returns, but is it the best approach to active investing? At its core, active investing intentionally deviates from an index with the goal of outperforming it. This approach involves deliberate positioning decisions, ongoing portfolio monitoring, and adjusting strategies based on market conditions and expectations of what areas of the market might perform well in the future. By contrast, many people with concentrated stock positions arrive there passively: through an inheritance, employee stock options or stock purchase plans, or simply because the stock’s value grew significantly over time.

Professional active investors, such as fund managers, may bet heavily on specific stocks or sectors, but still attempt to diversify across other investments and actively manage risk. In contrast, an individual investor with a concentrated stock position often relies on hope that the individual name will continue to be a winner. There can be an emotional element as well: if the stock was inherited or is related to the company where they are a long-time employee, or was purchased many years prior, the investor may be reluctant to divest. This increases “single-stock risk,” meaning that investor’s financial future becomes tied to the performance of just one company.

The dangers of over-concentration are well-documented, and there could be additional industry-specific risk if the stock is related to the investor’s employment. In a worst-case scenario an employee could lose their income stream at the same time as the stock they received as part of their compensation is dropping in the market. Intel is a recent example with mass layoffs occurring while the stock price dropped. Enron employees experienced something similar in the early 2000s, losing both their jobs and life savings because they held significant portions of their portfolios in company stock.

During the dot-com bubble at the turn of the century, many tech stocks that seemed unstoppable ultimately collapsed. The Magnificent 7 are not immune either. The chart below shows that the drawdown for these companies can be significant, and the climb back can take a while. For example, Tesla (TSLA) experienced its peak value on November 5, 2021. Following this, the stock declined by 68%, reaching its lowest point on January 3, 2023. This marked Tesla's maximum drawdown over the five-year period, representing the greatest loss for investors during this time. But then it experienced a dramatic rally, regaining all of its lost value by December 11, 2024. Other companies, such as Intel (INTC), are still recovering from their maximum drawdown of the past five years.

Source: Morningstar, Russell Investments. Any stock commentary is for illustrative purposes only and not a recommendation to purchase or sell any security. Max Drawdown definition (Morningstar): The peak to trough decline during a specific record period of an investment or fund. It is usually quoted as the percentage between the peak to the trough. Months to Recovery (Morningstar): The number of periods of the trough to peak incline during a specific period of an investment or fund.

Even for stock market “darlings”, there can be challenging periods and a long road to recovery. Most recently, semiconductor designer Nvidia (NVDA), which has been riding a wave of enthusiasm over Artificial Intelligence (AI) recorded the biggest single-day loss of value for any public company in history on news of potential Chinese competition. While it has recovered slightly since then, Nvidia stock is still around 20% lower than it was at the start of 2025. This recent downturn is another example of the magnitude of swings that can be experienced in a relatively short time and can take a while to recover from. The lesson is clear: no company is immune to challenges, and diversification remains essential to protecting long-term financial health. Investors can hope to regain the loss in a single stock – with the caveat that it could take some time, or may never happen. Or they can diversify to minimize the chance of those losses in the first place.

Diversification and changing trends

One thing to always remember: stocks can achieve theoretically unlimited upside but have a maximum downside of -100%. Owning a diversified portfolio allows an investor to benefit from the potentially unlimited upside of multiple securities, while reducing the likelihood of extreme losses due to the poor performance of just a single company.

While a concentrated position may produce dramatic highs and lows, a diversified portfolio allows participation in broader market upswings while providing the likelihood of a much smoother ride along the way. Even though we know diversification is key, it’s tempting to look at stocks Nvidia and wish we had put all our eggs in that basket. Even after its recent rout, its price is still more than 750% ahead of where it was at the end of 2022.

Many investors secretly hope to find the next big winner. They may look at the superstars in the market and decide to jump on for the ride. This is known as herd behavior. Well, let’s look at the risks that strategy can hold.

Should an investor pick the current winners and hope they continue upwards? The two graphs below, one backward-looking (choosing today’s best stocks five years ago), and one forward-looking (choosing the best stocks from 5 years ago, 5 years ago) show why today’s winners may not provide the most certain returns in the future.

Looking at the top 25 stocks in the S&P 500 as of December 31, 2024, it’s easy to imagine getting rich with a few strategic bets. U.S. market returns have indeed been driven by a small number of securities over the last five years, and 18 of the top 25 holdings currently in the S&P 500 outperformed the index over this period, as shown in the chart below:

Source: Morningstar, Russell Investments. As of December 31, 2024. Indexes are unmanaged and cannot be invested in directly. Past performance is not indicative of future results. NVDA=Nvidia, TSLA=Tesla, JNJ=Johnson & Johnson. Any stock commentary is for illustrative purposes only and not a recommendation to purchase or sell any security.

The reason these 25 names dominate the index today is precisely because they have performed so well over the past five years. But as we all know: past performance is no guarantee of future performance. So what are the chances they will continue on the same trajectory?

If we step back and put ourselves in the shoes of an investor from five years ago, the picture changes. Of the top 25 stocks in the S&P 500 as of December 31, 2019, less than half -- only nine -- outperformed the index over the following five years, as shown in the graph below. While holding Apple (AAPL) may have made you a winner, owning Pfizer (PFE), Disney (DIS), or Intel (INTC) could have resulted in a negative five-year return and lost you money during a period when the index as a whole nearly doubled, delivering a cumulative return of 97%.

Notably, Tesla and Nvidia were not yet among the top 25 holdings of the S&P 500 at the end of December 2019. Clearly, market leadership can change dramatically.

Source: Morningstar, Russell Investments. As of December 31, 2024. Indexes are unmanaged and cannot be invested in directly. Past performance is not indicative of future results. AAPL=Apple, INTC=Intel. Any stock commentary is for illustrative purposes only and not a recommendation to purchase or sell any security.

The bottom line

The best way for an investor to experience investment growth that helps them meet their financial goals would be to maintain a diversified portfolio over a relatively long time horizon. While a certain level of concentration can be acceptable for those seeking to actively outperform a benchmark, this approach requires a holistic view of the portfolio, factoring in risk tolerance, the ability to hold concentrated positions for an extended period, and a clear strategy for divesting when necessary. Overweighting and underweighting securities is fundamental to outperforming a benchmark, but the risk of holding just one or a few single stocks at extreme concentration levels can be high.