A Guide to Managing Concentrated Stock

Why Concentrated Stock Positions Matter

Managing a concentrated stock position is a challenge many investors face. Whether inherited, acquired through equity compensation, or grown from a smart investment, these positions can expose you to significant financial risk. This guide explores strategies to assess and manage these positions effectively.

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For a more detailed walkthrough you can watch a recording of our webinar "Managing Concentrated Stock"

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Also be sure to download your customized Planning Packet for more resources as you construct your plans!

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The First Question: Is It Too Much?

Understanding “Too Much”

No one-size-fits-all rule defines a concentrated position. Our default suggestion is that no single stock should exceed 5% of your portfolio but personal factors—like your family's financial goals and risk tolerance—are create other demands for your plan.

Key Questions to Consider

To better answer the question, "How much of one stock should I own?", it's helpful to take a broader look at your situation. Here are a few example questions that I find helpful:

• Would your financial situation be okay if the stock’s value dropped to zero?
• Does the stock serve a purpose, such as legacy or philanthropic goals?
• How volatile is the stock?
• Would you buy this stock at its current valuation?
• Is your salary tied to this company?
• Are you diversifying into other asset classes or industries?

Answering these questions provides a clearer picture of whether your position is too risky.

How Did You Get Here?

Common Paths to Concentration

Understanding how you acquired your position informs the best strategy for managing it. There are 3 primary ways that lead someone to having a concentrated stock position.

1. Inherited Stock: Received as part of an estate, often carrying built-in gains.
2. Good Investments: Investments that appreciated significantly over time.
3. Equity Compensation: Accumulated stock from your employer, sometimes restricted by vesting schedules.

Asking a few key questions like those above and finding which path led you to where you are will give you and your team a lot of information on how may be best to deal with it.

Strategies for Managing Concentrated Stock

1. Hold Until Death: Legacy and Tax Efficiency

Holding your concentrated stock until death may sound unconventional, but it’s one of the most tax-efficient strategies for passing wealth to the next generation. Here's how it works: when you pass away, your heirs receive the stock with a “step-up” in cost basis. Essentially, this resets the stock's taxable value to its current market price, eliminating capital gains tax on the appreciation that occurred during your lifetime. While simply planning to die likely doesn't fit your needs early on in your financial plan, it can be a powerful part of an overall planning strategy.

Benefits of the Hold-Until-Death Strategy:

• Tax Minimization: Heirs can sell the stock immediately without incurring capital gains taxes.
• Legacy Planning: Concentrated positions can serve as a significant asset for your estate.
• Simplicity: This strategy requires patience and holding more than active management during your lifetime.

However, this approach has trade-offs. The concentrated position remains in your portfolio, exposing you to volatility and market risk throughout your life. It’s critical to balance this with other diversification strategies to mitigate risk if the stock's value were to drop significantly.

Resource: Reference your planning packet, While I receive a Step-Up Basis Assets to explore this strategy in greater detail and understand how it fits into your estate plan.

2. Gifting Appreciated Stock: Generosity Meets Tax Efficiency

Gifting appreciated stock to a charity or donor-advised fund is a powerful way to align your financial goals with your philanthropic values. Instead of selling stock and donating cash, donating the stock itself avoids capital gains taxes entirely. The charity or fund can sell the stock without tax implications, maximizing the value of your donation. A common example of this would be establishing a Donor-Advised Fund that allows you upfront tax deductions on contributions while letting you parcel out your gifts over future years.

Key Advantages:

• Tax Deduction: You receive a charitable tax deduction for up to the full market value of the stock.
• Avoid Capital Gains: Neither you nor the charity pays taxes on the appreciated value.
• Simplified Giving: Donor-advised funds enable long-term, strategic donations without much administrative hassle.

Example:

Imagine you own a stock valued at $50,000 that you purchased for $10,000. Selling the stock would generate $40,000 in capital gains, potentially resulting in a $6,000+ tax bill. Instead, donating the stock eliminates this tax liability while providing a charitable deduction for the full $50,000 value.

This strategy is particularly impactful for individuals who are charitably inclined or those in a high-income tax bracket looking to optimize their giving.

Resource: Check out the Planning Packet Guide to Donor-Advised Funds for more information on setting up and maximizing your charitable contributions.

3. Hedging with Stock Options: Managing Risk Proactively

If selling your stock isn’t an option due to restrictions or personal preference, hedging can be a valuable alternative. By using stock options, you can limit downside risk while maintaining your position in the stock.

How Hedging Works:

Options strategies get complicated quickly but the general idea is to set a floor for how low you are willing to tolerate your stock's value dropping. Since this comes at a cost (from buying options contracts) you might also choose to offset that cost buy selling contracts for others to buy. Creating these boundaries limits your upside and downside but may provide the comfort needed to continue holding the stock.

• Buy Protective Puts: This option allows you to sell your stock at a predetermined price, providing a safety net if the stock’s value drops.
• Sell Covered Calls: You agree to sell your stock at a higher price in exchange for a premium, which offsets some risk while capping your potential gains.

Benefits of Hedging:

• Risk Reduction: Protect your portfolio from large losses during market downturns.
• Flexibility: Tailor your hedging strategy to fit your specific financial situation and risk tolerance.

Drawbacks:

• Cost: Options contracts come with premiums that can erode returns over time.
• Complexity: Hedging strategies require expertise and ongoing management.

This approach is best suited for individuals who want to retain their position while reducing exposure to significant market volatility. Keep in mind that employees of a company often face restrictions on trading derivatives tied to their company stock.

Pro Tip: Work with a financial advisor or options specialist to craft a strategy that aligns with your overall financial plan.

4. Diversify with a Completion Fund: Building a Balanced Portfolio

One of the most effective ways to mitigate risk is to diversify your portfolio. A "completion fund" strategy allows you to build around your concentrated stock position by investing in assets that balance its risks.

Methods of Diversification:

1. Gradual Selling: Sell small portions of the stock over time, reinvesting the proceeds into a diversified portfolio.
2. Investing New Income: Use additional income or savings to purchase complementary assets, reducing the overall impact of the concentrated stock.

Example:

Let’s say your concentrated position is in the tech sector. By reinvesting proceeds into real estate, bonds, and/or global equities, you can achieve broader exposure and reduce dependence on a single industry.

Why Completion Funds Work:

• Risk Management: It works to reduce the volatility associated with individual stock performance.
• Customizable: You can tailor the portfolio to meet your specific goals, whether that’s income generation or long-term growth.

Direct indexing is another effective tool for diversification. This strategy replicates the performance of an index while excluding your concentrated stock, ensuring no further exposure to that position.

Tip: Collaborate with your financial advisor to determine the right diversification strategy for your goals and risk tolerance.

5. Selling Strategically: Timing for Tax Efficiency

Selling your concentrated position outright is the most direct way to reduce risk. However, timing is critical to minimize taxes and maximize value. Understanding capital gains tax brackets can help you make informed decisions.

Three tips for Tax-Smart Selling Strategies:

• Take Advantage of Low-Income Years: If you anticipate a drop in income (e.g., after retirement), sell during those years to take advantage of lower capital gains tax rates.
• Offset Gains with Losses: Use tax-loss harvesting to offset capital gains with losses from other investments.
• Spread Sales Over Multiple Years: Selling in smaller increments can help you stay within favorable tax brackets.

Example:

In 2023, a married couple earning up to $89,250 in taxable income could sell stock and pay 0% on long-term capital gains. By planning the timing and amount of sales, you can strategically lower your tax bill.

Why Selling Makes Sense:

While no one enjoys paying taxes, the cost of holding a concentrated position often outweighs the tax burden. A thoughtful selling plan can reduce risk while keeping taxes manageable.

Resource: Refer to your Planning Packet for a visual breakdown of tax brackets and rates.

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Concentrated stock positions are a common but complex issue for investors. By assessing risk, understanding your options, and creating a personalized financial plan, you can navigate these challenges confidently.

Download Your Free Concentrated Stock Planning Packet Here!

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