A registered representative is reviewing a client's account and notices a significant portion (75%) of their portfolio is invested in a single technology stock, which has recently experienced high volatility. The client is 50 years old, has a moderate risk tolerance, and is saving for retirement in 15 years. What is the MOST appropriate action for the registered representative?
- ARecommend holding the position, as the client might benefit from future appreciation given their long time horizon.
- BObtain a signed waiver from the client acknowledging the risks of concentration and continue to monitor the position.
- CImmediately place a sell order for a significant portion of the concentrated stock to reduce risk.
- DSuggest diversifying the portfolio by gradually selling portions of the concentrated stock and reinvesting into a broader mix of assets.
Show answer & explanationAnswer & explanation
Correct answer: D. Suggest diversifying the portfolio by gradually selling portions of the concentrated stock and reinvesting into a broader mix of assets.
The client has a highly concentrated position (75%) in a single volatile stock, which is unsuitable given their moderate risk tolerance and retirement savings goal. The most appropriate action is to recommend diversification. This involves gradually reducing the concentrated risk by selling portions of the stock and reinvesting into a diversified portfolio, aligning with their risk tolerance and long-term goals. Holding the position or simply obtaining a waiver does not address the unsuitability. Immediately selling a large portion might not be in the client's best interest due to potential tax implications or market timing issues without prior discussion and agreement.
Why the other options are wrong
- A. Holding such a concentrated, volatile position is unsuitable for a client with moderate risk tolerance.
- B. A waiver does not absolve the representative of suitability obligations; the underlying risk remains unaddressed.
- C. While risk reduction is needed, an immediate, unilateral sell order without client discussion and agreement is inappropriate and could have negative tax or market impact.
Concentration Risk Mitigation
For clients with concentrated positions unsuitable for their risk profile, registered representatives should recommend diversifying by gradually reducing exposure to the concentrated asset and reallocating to a broader, more diversified portfolio.
- Concentration risk is typically unsuitable for moderate/conservative investors.
- Gradual diversification helps mitigate risk and manage tax implications.
- Client's risk tolerance and time horizon are key factors.
- Requires discussion and agreement with the client.
Memory trick: A mountain of risk needs to be spread out like a forest.