401(k) Plan Investors Should Take Notice of Recent Report on Concentrated Stock Risk
Although not everyone agrees about the value of diversification, 401(k) investors would be wise to take notice of a J.P. Morgan report relating to concentrated stock risk. See Michael Cembalest, The Agony and the Ecstasy: The Risk and Rewards of a Concentrated Stock Position, Eye on the Market Special Edition, J.P. Morgan (2014). The J.P. Morgan report highlights how risky investing in even large companies can be and emphasizes the risk that investors take when they fail to diversify.
According to the J.P. Morgan report, 40% of all stocks that had been a part of the Russell 3000 suffered a catastrophic loss from 1980 to 2014. Catastrophic loss was defined as “a decline of 70% or more in the price of a stock from its peak, after which there was little recovery such that the eventual loss from the peak is 60% or more.” Id. at 4.
The report also makes clear that even the largest public companies were not immune to large losses—since 1980, 320 companies have been deleted from the S&P 500 due to significant distress. The 320 “deletions . . . were a consequence of stocks that failed outright, were removed due to substantial declines in their market value, or were acquired after suffering such a decline.” Id. at 3.
The report identifies 10 factors, including government policy changes, that are outside of company control. And it concludes with the following: “The factors outside management control . . . are a formidable list, and have grown in complexity since we first drafted this report 10 years ago. This is perhaps the most important epiphany we gained from the study: that exogenous forces may overwhelm the things we can control.” Id. at 36 (emphasis omitted).
The J.P. Morgan report serves as a good reminder of the importance that 401(k) plan participants should place on modern portfolio theory and its emphasis on diversification.