In 2022, Meta’s stock dropped almost 80% from its high. Employees and long-time shareholders who’d built most of their wealth in company stock watched a huge portion of their portfolio disappear in a matter of months. Meta recovered eventually, but this shows how having too much invested in one stock is risky. This is the problem diversification solves.
What is portfolio diversification and how does it work?
Portfolio diversification means spreading your money across different investments, companies, sectors, and sometimes asset classes, so that no single holding can sink your entire financial picture. If one investment performs badly, the rest of the portfolio absorbs the hit instead of your whole portfolio taking the blow at once.
Diversification isn’t a guarantee against loss. A diversified portfolio can still go down in a broad market decline. What diversification actually protects against is company or industry-specific risk — the kind tied to one business’s (or industry’s) management, competition, or bad luck, rather than the market as a whole.
Diversification is important for all investors but especially those sitting on a large, appreciated, concentrated position, where diversifying by simply selling would trigger a steep tax bill.
Why concentration is risky
A position is generally considered concentrated once a single stock makes up more than 10% of your total portfolio. Go well above that, and your financial outcome starts to depend heavily on one company’s decisions rather than the broader economy.
This happens gradually and often without anyone intending it. An early employee’s equity compounds over a decade. A long-held stock keeps appreciating while the rest of the portfolio stays flat. Either way, the resulting position carries risk that has nothing to do with skill or conviction, it’s simply math: the bigger one holding gets relative to everything else, the more that one company’s fortunes decide your outcome.
Common ways you can diversify
For most portfolios, diversification doesn’t require anything exotic:
These methods work well when you’re building a portfolio from scratch, contributing new money over time. They’re much less useful once you’re staring at one already-large position, since none of the three actually gets you out of concentration risk. They only prevent it from getting worse.
The problem when the concentration is already there
Rebalancing a 401(k) is straightforward. Rebalancing a position where one stock has grown into 40% or 60% of your portfolio, with most of that value being unrealized gain rather than money you put in, is a different problem entirely. Selling enough to meaningfully diversify means realizing a large capital gain and paying tax on it, often tens or hundreds of thousands of dollars, in the same year you sell.
This is the situation a lot of long-tenured employees and early investors in a single company find themselves in. Diversification is the right move for them on paper, but the tax cost of getting there the conventional way is steep enough that people put it off, sometimes for years, while the position keeps growing and the risk keeps compounding.
Do exchange funds help diversify a portfolio?
A handful of strategies exist specifically for diversifying a large, low-basis position without triggering the full tax bill up front: direct indexing, tax-aware sale strategies spread across years, and exchange funds, where you contribute your shares to a pooled fund and receive a diversified basket in return instead of cash.
An exchange fund works particularly well for this case because you’re not selling at all, you’re exchanging one concentrated position for a diversified one. A Glidepath exchange fund, for example, lets you contribute appreciated shares and hold a diversified basket instead, with the tax on the original gain deferred rather than due immediately. If a single stock has grown to make up a large share of what you own, it’s worth checking whether your position qualifies before deciding to sell outright.
What this means for you
Diversification means not letting any single investment decide your financial outcome. For most portfolios, that’s achieved through ordinary asset allocation and rebalancing. For a portfolio where one stock has already become a large share of your portfolio (through equity compensation or long-held company stock) finding a way to diversify without triggering capital gains is key.
When you’re ready to diversify without the huge tax bill, see if you qualify for the Glidepath fund.