FINRA Series 6 Investment Company and Variable Contracts Products Representative ExaminationOpening and Maintaining Customer Accounts and Investment RecommendationsHard
A client has a concentrated position in their employer's stock, representing 70% of their total investment portfolio. They are approaching retirement within 5 years and express concern about market volatility impacting their retirement savings. The registered representative should recommend which of the following strategies?
- ARecommend selling a significant portion of the employer stock and diversifying the proceeds.
- BAdvise the client to use margin to buy other stocks, hedging the concentrated position.
- CEncourage the client to hold the position, citing potential future growth.
- DSuggest buying more of the employer's stock to average down their cost basis.
Show answer & explanationAnswer & explanation
Correct answer: A. Recommend selling a significant portion of the employer stock and diversifying the proceeds.
A concentrated position represents significant uncompensated risk, especially for a client nearing retirement who is concerned about volatility. The most suitable recommendation is to reduce this concentration by selling a portion of the stock and diversifying the proceeds to mitigate risk and preserve capital.
Why the other options are wrong
- B. Using margin increases leverage and amplifies risk, making it highly unsuitable for a client concerned about volatility and nearing retirement with a concentrated position.
- C. Encouraging holding a highly concentrated position, particularly nearing retirement, increases risk and is generally unsuitable.
- D. Buying more of the employer's stock would further increase concentration and risk, directly contradicting the client's concern about volatility.
Concentration Risk Mitigation
Concentration risk arises from holding a large portion of a portfolio in a single asset or sector. Mitigation typically involves diversification, which reduces overall portfolio risk.
- High concentration increases uncompensated risk.
- Especially problematic for investors nearing retirement or with low risk tolerance.
- Diversification across different asset classes, sectors, and geographies is key.
- Strategies include systematic selling, hedging, or using options (though options add complexity).
Memory trick: Concentration: TOO many eggs in ONE basket, so DIVERSIFY to BALANCE the risk.