We always advise our clients to keep their individual stock holdings to five percent or less of their entire portfolio value. Otherwise, they may be taking on substantially more risk than they realize.

A recent case in point strongly supports this advice. Today’s Wall Street Journal reported that British Petroleum (BP) stock dropped 16% yesterday and is down approximately 50% for the year, as a result of the oil leak disaster in the Gulf of Mexico. If a substantial portion of your portfolio was invested in BP stock, it could have severely impacted your financial future.

Events such as the Gulf oil disaster occur very unexpectedly. While the impact on BP’s stock is easy to understand, there may be other companies that will also be impacted significantly. Others gas and oil companies may suffer as a result of a backlash against the oil drilling industry. Tourism-related industries could also be impacted.

There are all types of scenarios that can severely impact a company’s earnings and stock price. Environmental disasters (hurricanes, draughts, floods, earthquakes, volcanoes, tornados, etc.), product liability litigations, fraud, and economic and political events, can all occur with little or no warning. Nearly every company bears risk to these types of events and others we haven’t thought about.

We have advised many clients to reduce or eliminate stock holdings. In many cases subsequent events have made those reductions look very wise. When clients come to us with large individual stock holdings, it can be quite difficult to get them to significantly reduce those holdings.

If you have a stock that has appreciated in value to the extent that it is now worth substantially more than 5% of your total portfolio’s value and you hesitate to sell it because you are just sure it will rise further, consider the following: Assume that instead of owning that stock you had cash equal to the current market value of the stock. Ask yourself if you would invest that sum of money all in that one stock, given that its price is now historically high. In most cases, clients say no they would not do that; that would be too risky. So why then would you continue to hold that much stock in your portfolio?

Now that the market (DOW) has rebounded significantly from its low of near 6500 in March 2009 to over 10,000, it’s a good time to review your holdings to see if there are any stocks whose values now represent too great a percentage of your total portfolio. If so, we strongly urge you to consider reducing those holdings. You’ll sleep better at night.