A registered representative is reviewing a client's account, which holds a significant concentration (75% of liquid net worth) in a single technology stock. The client, a 50-year-old executive at the technology company, has expressed concerns about the company's recent performance but is emotionally attached to the stock. Which of the following strategies is MOST appropriate for the registered representative to recommend to mitigate risk while respecting the client's emotional attachment?
- AImmediately sell 50% of the concentrated position to diversify the portfolio.
- BDiscuss implementing a covered call strategy or a gradual liquidation plan over time.
- CAdvise the client to hold the position, as their emotional attachment indicates strong conviction.
- DRecommend selling the entire concentrated position and reinvesting in a broad market index fund.
Show answer & explanationAnswer & explanation
Correct answer: B. Discuss implementing a covered call strategy or a gradual liquidation plan over time.
The client has a significant concentration risk and concerns about performance, but also an emotional attachment. Immediately selling a large portion or the entire position might be too drastic and alienate the client. A covered call strategy can generate income and offer some downside protection (up to the strike price) while allowing the client to retain the stock. A gradual liquidation plan respects the emotional attachment by spreading sales over time, allowing for diversification without a sudden, jarring decision. Both options mitigate risk incrementally.
Why the other options are wrong
- A. While diversification is needed, an immediate 50% sale might be too aggressive given the client's emotional attachment and could lead to market timing issues.
- C. Advising to hold the position ignores the significant concentration risk and the client's expressed concerns about performance, which is a breach of suitability obligations.
- D. Selling the entire position is often the ideal solution for concentration but directly contradicts the client's emotional attachment, making it impractical and potentially alienating.
Concentration Risk Mitigation (with Emotional Attachment)
Strategies to reduce the risk associated with a highly concentrated investment, especially when the client has an emotional attachment, including gradual liquidation or options strategies like covered calls.
- Concentration risk poses significant downside potential.
- Emotional attachment can hinder rational financial decisions.
- Gradual liquidation allows for diversification over time.
- Covered calls can generate income and offer limited downside protection, reducing overall portfolio risk without immediate full sale.
Memory trick: Spread your bets, don't just hold; for emotional stock, a gentle fold.