The Diversification Trap Nobody Sees Coming | Fundamentals of Investing

Most people think their biggest investment is their portfolio, but for many executives, it's actually their career. If someone is earning several hundred thousand dollars a year, their future income could represent millions of dollars over time. Nolan, when we say someone's career is their biggest investment, we're really talking about earnings power, correct?

That's correct. And a lot of times that future earnings power is the largest asset that someone has.

And yet most people spend more time diversifying their portfolio than thinking about the risks tied to their career. Today we're talking about the executive diversification trap. Welcome to Fundamentals of Investing. I'm Brian Dress, Director of Research here at Left Brain and also an advisor, joined as always by Nolan Langford, our Chief Investment Officer and CEO. Nolan, welcome to the program.

Thank you, Brian.

Thanks, Nolan. We're talking today about the concentration that can occur by working at a publicly traded company. So we're going to start out, first of all, talking about how concentration builds, Nolan. So for many executives, concentration in employer stock doesn't happen all at once. It builds gradually through stock compensation, bonuses, and career growth. Over time, that exposure can become very large. When you work with executives and senior professionals, is it common to see several million dollars tied up in a single stock?

It's definitely not uncommon. Especially if that executive has stuck around at the company for a while. And as you mentioned, usually the higher you go, not only your pay increases, but also your attachment to that company's stock grows. Absolutely.

So, Nolan, if someone is earning $500,000 to $1 million a year and a portion of that comes in stock, talk about how quickly that position can grow.

It can. And as we've seen, there's a lot of publicly traded companies now where they cap your income you can earn, like everybody at the company will have a cap that they can earn.

—in cash comp.

In cash comp, excuse me. So, if you're making, like in your example, $500,000 and the cash comp is $200,000 at the max, a lot of them will pay the additional $300,000 in company stock. And if you go a few years of doing that, it doesn't take long for that, the stock part of your net worth to grow pretty rapidly.

Yeah, that's exactly why we've been doing these series of videos, Nolan, is we talk to executives all the time, work with quite a few of these executives at publicly traded companies. This is a common issue that tends to happen. And people think a lot more about the cash comp that comes in on a week-to-week basis, but a lot less about the, the stock comp. And that's something we want to make sure people are considering. So, Nolan, it's not unusual for someone to wake up and realize they've got $3, $5, $10 million in the company stock where they're drawing their paycheck. And when you combine that with salary bonuses and future comp, all depending on the same company, the financial exposure to that one company becomes huge. What's your reaction to that?

I agree with you, especially if the stock has been a winner.

Yeah. Oh yeah.

You know, if you've received, in my example, $300,000 worth of stock for the last 4 to 5 years and the stock has gone up over that time, a significant portion of your net worth could be tied to that company stock. Absolutely.

So this is a problem that we know a lot of people are out there facing, whether the stock is going well or whether the stock is going poorly. Similarly, you have an issue there. Let me just give a quick example. So, if someone has $750,000 of income on a yearly basis and $5 million in company stock, and that industry goes through a downturn, the income, bonuses, and investment portfolio are all affected at the same time. So, is that where the real concentration risk starts to show up in those sort of situations? Yes, it can show up there.

And we're starting to see some of that today with this talk about AI disruption. You know, there was a news article that came out not too long ago that just talked about the difference between white-collar and blue-collar jobs. And right now the white-collar jobs are in the crosshairs of AI. So you could have some of these high-level executives where their jobs have been eliminated at the same time their stock price, because of this AI-eaten-software theory that's out there, right? That could have an impact not only on their income statement but also on their balance sheet.

Yeah, so I think, Nolan, I know everybody's aware of AI, but they haven't necessarily thought through all the effects that may come along with it. So as you said, Nolan, there are some companies where they may be disrupted, so the company won't do so well. They'll need less people working for that company. And so if you're in that company, own a bunch of the stock and depend on a paycheck there, talk about what could possibly happen to you in a worst-case scenario like that.

Yeah, in the worst case, it'd be pretty painful, especially if you've had some lifestyle creep. You know, I know back in the day when Silicon Valley was really doing its thing and you heard stories about people going to parties and cocktail parties and, you know, pulling out their stock option statement and having that be a, having that be a big measuring stick for people.

That seems terrible to do at a party.

And so if you start to feel that you are wealthy because your stock has appreciated, you may take actions in your personal life where your expenses tend to go up because you feel wealthier. Right. Now, if the pendulum swings the other way and you're negatively impacted, I mean, that can have a big, not only financial impact, but a psychological impact as well.

Okay. So, we're definitely saying you may have a lot of this concentration, but something that needs to be addressed in some way, shape, or form. So, let's talk about one of the impediments to that, Nolan. And it's oftentimes difficult for people to sell employer stock. So, People work for a company, feel loyalty toward it, know it's doing well, and so it makes it really difficult for them to part with a single share of that stock. When executives recognize this kind of concentration risk, we know it's difficult for them to sell stock. Is part of that— is a big part of that emotional attachment to the company that they've spent years helping to build?

Yeah, I think this— there's a few layers to this, and we would just encourage executives to use their left side of their brain when they're thinking about How much company stock do I have and how much should I have? I think it's easier, Brian, on the way up. If you're a company like NVIDIA or one of these AI winners where the stock has done well. Yeah, I think it's easier to sit there when things are going well and think about, okay, trimming some stock. However, if you're on the side of the so-called AI losers at this point, then it's a little bit more difficult for a few reasons. Think about if you're in a software business where the narrative is you're being eaten by AI, right? And the stock price is down 50%. Now, we've seen some of these cases where they've come out and reported, and then the CEO makes a really big stand, and then he comes out, or he or she comes out and buys the stock in the open market, right? And tells the market, I'm buying the stock. This is going too far. We've seen this just this quarter where it's not only the CEO, you have also board members, directors, and other C-level executives They'll take money, cash out of their pocket to buy the stock as a show of faith and support. Right. Now, can you imagine being an executive that then goes out and sells the stock and it has to get reported to the public? Yeah, that's not going to go over too well. So there could be a little bit of peer pressure or some other elements at risk other than what's in my best economic interest.

Okay. So that's one part of it. Another part's FOMO, what we call FOMO, fear of missing out. So I've spoken to some people that are in this situation. They have a concern, they sell some of their stock and it continues to rise. Rise, they're going to feel like they made the wrong decision. So talk to me about how you think about the FOMO, managing that psychological barrier to sort of making the right decision here.

I'm going to say you're right. That's a good point. And FOMO can swing two ways. You can fear of missing out if the stock goes up, a stock that's been rising and continues to rise. But it also is FOMO if your stock's fallen 50%, you could almost think Oh, well, it's too cheap now. It's got to go up. So, you've been a recent loser. Right. But your fear that the elevator is going to go up and you're not going to be on it. And so, I think those are two different psychological angles. I mean, it's still FOMO, but I think the psychology around them are completely different. There are some things that you can do. I like the idea of we keep using software, but we could use biotech, we could use financials today or anything else. Let's use financials. So let's say right now we're in this private credit issue. We have the war going on. Who knows what the market's pricing in, whether it's recession, interest rates, whatever. But financials have been weak to start 2026. So if I have a lot of bank stock and I'm a bank executive, I could feel that same way. Hey, my stock's down 15% or 20%. If I'm at Apollo or Blackstone or Blue Owl or Goldman Sachs, I can be like, this is not a good time to sell. I think the clouds are going to part sometime soon and my stock's going to regain its upward momentum. All right. So if I'm at Goldman Sachs, maybe I, instead of it being Goldman Sachs, maybe I trim some Goldman Sachs stocks and buy Morgan Stanley. That way I still have some diversification in the same sector. And sectors usually rise together. So that's an easy way. It's kind of like a step one baby step. Okay. If I don't want to get out of the stock, but generally that diversification can help you. You know, maybe you're not— you don't feel great about selling the stock because you think it's going to continue to go up. Chances are if your stock's going to continue to go up, it's not going to be the only one. So can we find some other stock where we can diversify ourselves and still get the upward momentum?

Okay. So looking to get Exposure somewhere else, maybe if you're in that situation where your stock is downtrodden rather than sitting there and hoping that's going to get better, maybe taking advantage of, you know, positive movement in other parts of the market might be a good way to get started with diversifying from that perspective. I like it.

And, you know, though, we just talked about the two extremes where you have these extreme winners. Yeah. And we think it's going to keep winning. So I don't want to sell. And then the extreme losers where the stocks are down and now I'm caught into this mental funk of is it the wrong time? But there's a whole different group of stocks that just haven't done much of anything over a long period of time. Sure. They've never really worked. And those people, it's a completely different psychology for those people as well. So executives, give you a number of scenarios where executives really need to think through what they, what the plan is.

So in my experience so far with me, with meeting with people in this situation, Nolan, the word that comes to mind for me is paralysis. And especially because sometimes the numbers are enormous in these contexts. Sometimes someone's got $5, $10 million of stock. And so every time they make any kind of a decision, it feels like the weight of the world is on them there. Does that pressure lead people sometimes to delay doing anything? That's a good point.

Yes, of course it does. The paralysis analysis. Concept. But even not making a decision is making a decision. Oh, yeah, absolutely. I think it gets more difficult too, Brian, if that stock— you mentioned $5 million in stock. If we've seen this before, where it's $5 million in stock, the company really hasn't done much. Like, it wasn't like the cost basis is $1 million and it grew to $5 million.

Right.

Some cases the cost basis is $5 million. They earned that $5 million. Right. Yeah. But if that stock is especially difficult, if it pays a dividend. Okay. Now it gets more difficult because even at 2% dividends, $100,000 a year in cash. Right. And so, that's more of an incentive to sit on your hands.

Yeah, it seems like it's a lot of psychological barriers in these situations, and that's what we want to help people discover a way through. So, we want to talk about breaking through the inertia problem here. So, Nolan, once someone realizes they're highly concentrated in employer stock, next challenge is definitely doing something about it. Is the first step simply understanding how large your exposure really is?

Yes. Yes. And in relation to something else. So, it's one thing to say $5 million in a vacuum. It's completely different if my net worth is $7 million and I have $5 million in employer stock. That's very different than if my net worth is $25 million and I have $5 million in employer stock.

Right. When people do see the numbers clearly, it often changes the way they think about diversification. What's been your experience as far as that goes?

Yes, it is definitely an eye-opener, particularly if you're in the first case that I mentioned where that employer stock makes up over 50% of your net worth. It definitely can be eye-opening. I'm not sure it's much easier to make a decision at that point. Right. But certainly your eyes are wide open.

Okay. And I think part of the problem too, Nolan, is sometimes people look at things as an all or nothing, black or white kind of situation. So they've got all this stock and you speak to them and say, okay, maybe it's time to do something about it. And they think, well, either I sit here and do nothing or I'm just going to sell everything all at once with no consideration of taxes or anything along those lines. And so, seems to me that some sort of a process over time is the best way to start diversifying away from these concentrated exposures. So, is that how you would approach it with a client? Yes.

And as you know, we are, We customize everything here so we don't boilerplate everything. Right. And so every client is different, you know, depending on their age bracket, their tolerance for volatility, what their tax situation is like, and then their, you know, their stomach, quite frankly, for handling that volatility or that risk. I will say another thing. It depends too, Brian, on how they own the stock. We keep saying $5 million in a bucket. Sure. But it's different. You know, if I've gotten $5 million in restricted stock units, that's different than if I got $5 million in non-qualified stock options. Sure. That's very different than if I have $5 million in my employee stock purchase plan. I can also own it in my 401(k). If it's 25% in each bucket, I'm going to approach that differently than if it's just $5 million in one bucket. So there's a lot of nuances here that should drive somebody to kind of sit down, talk to a professional, somebody that's dispassionate. That can give them an outside, honest, objective, unbiased view. And think about it like an investor, not necessarily an employee. Right.

Yeah, I think that's the problem is it's the two get conflated. You're, you're an investor in the stock and an employee at the, at the company. But those are two different, very different things and two very different ways to interact with the company. And so, it sometimes helps to talk to someone not involved in the situation in order to peel those two apart from one another. So, we've talked about this example. Sometimes people have several million dollars of stock in a single stock. Selling everything once at once really isn't realistic, is it?

No, it's very rarely, do you see that happening either on the way up or on the way down. And generally, they didn't accumulate the stock all in one go. No. So, it kind of makes sense to think about a plan on the way out.

Yeah, slowly, uh, just disinvest yourself of a few shares at a time, a few hundred thousand at a time, and easier to manage some of the externalities that come along with that. So instead of selling everything at once, we think building a structured plan over time makes sense, especially around your vesting schedule and your compensation cycles. And it can make the process much more manageable. The way you're paid, the way you receive restricted stock units, things along those lines all have huge tax implications. That's something that needs to be planned out over time. I did wanna talk about one, uh, final thing today, which was the emotional side of the decision. So definitely seems like emotions get involved a lot. Well, we know that happens a lot in investing, but in this particular situation, it certainly does. Uh, when people are dealing with positions worth several million dollars, the emotional side becomes very real. Do you find that reframing the decision from selling the company stock to managing risk helps people move forward on a plan. It can.

And, you know, it's not just people who have multiple millions. Sure. Even people who have just a couple hundred thousand or hundreds of thousands or even tens of thousands at some point. Right. The decision can be emotional and not an intellectual exercise. It's emotion. We talked about before, if you're an employee at a company, then you're all in. You're rooting for that company. And a lot of times you've got your blood, sweat, and tears into some product or project launch. Yeah. So you want this team to win and it feels like you're being not loyal if you sell that stock. Mm-hmm. So it can get very tricky very quickly. You know, even employees that haven't been in the company long, you know, a lot of clients still get sign-on bonuses and those can be in shares. Yeah. So even if you're with a company for 6 months or whatever, you don't know much about it, but you're certainly rooting for them and you want to feel loyal and look like a team player. So it doesn't feel natural to then start thinking about how do I divest my shares? And so that is something that needs to be managed and to be thoughtfully thought about. And I think over time, I think we said earlier, I think the key is looking at it like an investor. And not necessarily an employee. I think that's the way to look at it. Everybody in these days, this day and age, is a free agent. You know, think about it like the NFL. That's right. We're in the new league season where they're signing free agents all over the place. Employees are that way as well. Yeah. Even CEOs, they come and go. So we're free agents. So we have to look at this stock in a really dispassionate manner. Yes. And just size up the investment and take our emotions, take what we think is our loyalty, and we have to kind of take that out of it.

I agree. And I also want to talk to the people out there who have this big concentration building, haven't done nothing yet, because there's— we know the fear of the unknown is huge in a lot of different situations, this being one of them. So I want you to talk from your experience, you know, the people you've worked with that you've helped to start diversifying and reducing their concentration. Do you see a sense of relief there? Talk about what that looks like. I do.

I do. And I think it's much easier. We talked about these winners and losers. I think there's another group where it comes a little bit more naturally to start to divest and diversify. And those are people that are retiring. Okay. I've had a lot more success there as people start to retire, like, okay, well, I'm going to be gone from this company. I'm okay with starting to remove some of these shares from my portfolio. Yeah. For me, that's been really a lot, a lot easier. But I think you're right. Everybody should go through the exercise. I'm thinking about now just kind of where the market is. We have this conflict going on in the Middle East. There's always something happening in the market. Sure. So you always have this group of winners and losers, and some groups are recent winners, but they were losers, and some of them are recent losers, but they were winners. Right. And so you have to think about that. Think about like oil companies today. Um, with the price of oil spiking, oil has been a really recent winner. Yes. Uh, but if you go back, uh, several years ago when oil prices were, you know, closer to $40 or $50 a barrel, those weren't winners. No. And a lot of those executives and high-ranking officials there tend to get a lot of company stock. Now they pay dividends, but historically there have been a lot of periods where they have not performed, um, on the upside at all. And if you think about those people, would they have done better trimming some of those shares to buy other sectors or other investments? And not only does it diversify your portfolio, but it probably builds your net worth and gives them a smoother ride. Yes. It's difficult to do, but every employee needs to think like an investor. I think also too, I, you know, these decisions aren't easy. My heart goes out. To these executives because it's complicated. It's nuanced and it's complicated. And so, there's a lot to contend with. And I think help is much tougher to get too. Nowadays, you know, we talked about going out, getting an independent, objective, and unbiased opinion. Right. Where are you going? Because a lot of investment advisors themselves don't know individual stocks. They know ETFs, they know passive indexing. So, if I'm with ABC Company, healthcare, biotech, software, you name it. And I go talk to somebody, it needs to be somebody that's well-versed, not only in company stock generally, but in my company stock. And in other company stocks in my industry. And so, the list starts to shrink.

We definitely would encourage people to think about getting on this journey of reducing the concentration just because if you can get that exposure no longer hanging over your head, over your financial life, it does feel certainly better. And there's definitely currency in feeling, having a little more peace of mind and being able to sleep at night knowing that all your money's not in one, you know, tied up in one basket. So a few takeaways here as we close out the video. For someone listening who receives significant stock comp from their employer, there are a few simple questions they can ask to clarify their situation. Questions like, what percentage of my net worth is tied to my employer? What would happen if my company or my industry struggled? Or do I actually have a plan for managing that exposure? Nolan, when executives start asking those questions, does it usually lead to a more thoughtful approach to diversifying? It does.

It does. And I'm going to throw one back at you. Yeah. In some cases, they need more concentration. So, I've seen examples where you're right, generally what you see commonly, especially if somebody's been with an employer for multiple years, which tends to be the clients we work with. Generally, you're going to see what we've been talking about a long time, which is more company stock and more of a need for diversification because they've got a lot of company stock. Right. But I've also seen the other side of it as well, where somebody works for a company that is a good performing company, sales, revenues, earnings, the business is on the come. Yeah, but they don't have a lot of exposure. And in some cases they need to increase their exposure to company stock, especially if some of these plans are like— some of these employee stock purchase plans give you an incentive to buy the stock. Some of the more generous ones are like 10% to 15% below market value. So, you're locking in a free profit. So, every now and then you can see a case where it makes sense for somebody to add exposure. So, exposure definitely needs to be reviewed either way.

Yeah, no matter what you're doing, if you're in one of these publicly traded companies, it does make sense to reassess exactly what you're doing, whether you're concentrated or you have no concentration. I'm going to give you the last question here, Nolan. What's the biggest mistake that you've seen executives make in terms of their executive compensation?

Apathy. Okay. Just kind of not doing anything. There is a— we didn't talk a lot about this earlier in the video, but there's another plan most of the Fortune 500 companies have called the deferred compensation plan. Yes. It allows executives to take their income and shelter it in a plan. So as a quick example, I make $500,000 a year. I put $50,000 into a deferred comp plan. At the end of the year, you know, my W-2 says I made $450,000. Right. So savings today. Now, there are some rules around this deferred comp plan. You know, I have to choose when it's going to come out. And that sort of thing. But when it comes out, it's taxable. Right. But it's a plan that not a lot of executives use. It's probably one of the more sparsely used programs that I could use at my company. So I would just say not taking stock of all of the employee plans that are available to me. We do these series for publicly traded company employees because there's a lot more bells and whistles in their plans. A lot more things to navigate. And so I would say that would be the one thing that I would encourage the investors and the successful employees to do is to pay attention to all of the opportunities to participate in the company plans. And it can definitely have a positive impact on your net worth over time.

I think that's something that we see across not only the stock compensation problem, but also people leaving old 401(k)s at old employers and things like that. What we're saying here is take direct action, make sure you are in control of what's going on and not just letting it happen to you. Something so important as your financial life and your financial plan and wealth building strategy. Take full control of that. And that's something we can help with. So, Nolan, as we discussed today, for many executives and high-income professionals, their career already may be their biggest investment. The key is making sure the portfolio helps manage that risk rather than amplifying it. For those of you who receive stock compensation from your employer, we'd be curious to hear from you. What percentage of your net worth is currently tied to your company? Let us know in the comments. We'd love to interact. And if you found this conversation helpful, please like, share, and subscribe the episode with someone who might benefit from it. We know there are a lot of people out there, some of your coworkers being one of them. And if you'd like to learn more about the topic, we've put together a resource called The Executive's Guide to Company Stock, which talks— walks through some of the key considerations for professionals who receive stock compensation. We'll include a link to that in the description. Thank you for joining us. We'll see you again next time on Fundamentals of Investing. Thanks, Nolan.