It’s been proven that a well-diversified portfolio can be crucial in attaining long-term financial goals – spreading your investments across asset classes balances the risk and reward inherent to any one specific asset. However, if your current or previous benefits package includes company stock, you may find that this creates a concentrated position in your portfolio, a risk that could potentially derail your financial plan.
While concentrated stock can generate significant wealth for a successful company’s executives and employees, it also brings added risk to their financial plans. An investment plan that lowers your risk profile while maximizing returns must consider your overall financial objectives, and these often conflict with the higher risk associated with holding concentrated stocks.
Here are some strategies for incorporating concentrated stock into your investment portfolio while remaining on track with your financial goals over time.
Rolling Sale of Concentrated Stock
If you are concerned about having a considerable amount of your portfolio tied up in one company, but wish to retain some upside appreciation potential, the rolling sale of your concentrated stock is a good strategy. Put simply, this strategy involves selling the stock on a rolling basis, either in a stated portion, percentage, or number of shares over several years. Also called “staged selling,” many investors are drawn to this strategy for tax purposes. Rather than sell all of your concentrated stock in one large sale, which would trigger a potentially massive tax event, depending on the stock type and how long you have owned it, a rolling sale strategy spreads the tax impact on your returns over many years. It also allows for better cash flow planning, helping to ultimately create a more accurate financial plan.
Donating to Charity or Gifting
For an investor interested in reducing income taxes on their annual tax return, donating the proceeds from concentrated stock to a charitable organization is an effective strategy. Any monetary gift to a charity provides the donor with a tax deduction. But before you sell off your assets and donate the proceeds, consider how to maximize your donation.
Planning to sell a highly appreciated stock with the goal of a charitable donation may not be the most cost-effective form of giving. The capital gains of your asset will still be subject to taxation before you give the proceeds to charity – effectively lowering the value of the gift by forfeiting some of the proceeds to Uncle Sam.
Provide the recipient organization the most value by gifting the actual stock shares to the charity directly, or by contributing them to a donor advised fund where you can issue grants to various charities until the funds are exhausted. This option is more valuable for both parties: the charity will receive the full value of the gift while the donor gets their full tax deduction. Thanks to the tax classification of charities, the organization receiving your concentrated stock could sell the shares themselves with no tax liability. (Note: this option does not cheat the IRS out of tax revenue, it just maximizes the value of your gift for both the charity and your tax deduction).
Hedge Your Bet with an Equity Collar
Implement an Equity Collar – one of the more common hedging strategies for concentrated stock holders, this involves buying (going long) a put-option on the stock while simultaneously selling (going short) a call option on the stock, with both contracts being equal in duration. Without getting too technical, this strategy effectively creates a structure that provides downside protection and upside potential. This approach would work best for a high net worth investor who is focused on preserving value, is uncertain about the stock’s future, and is willing to pay higher fees to put the structure in place.
Think Outside the Box (Or Hire Someone To)
In some cases, you can transfer your holdings “in kind” to a Separately Managed Account (SMA). Think of this as a custom mutual fund where you can see the underlying holdings. If your stock is already one of the SMA’s underlying holdings, they may allow you to transfer positions to them so they can manage on your behalf. This creates an organic way of rebalancing your portfolio in a tax-efficient manner as you grow your wealth over time.
Measure Your Overall Exposure
Find out how much exposure you have elsewhere in your portfolio. For example, if you work at Apple and you own the S&P 500, you already have ~5% exposure in this fund alone. If you analyze all holdings you may find additional overlap elsewhere. As a company, Wealthspire Advisors typically advises capping total concentrated exposure to 4-5% of your overall portfolio size. We design investment portfolios that are in line with your personal goals, your financial timeline, and your risk tolerance.
Maintaining concentrated stock can be beneficial in certain cases, but it is inherently risky when not done properly. Therefore, concentrated stock must be viewed within the framework of your larger investment and financial strategy. For a comprehensive view of your portfolio, consult a trusted financial advisor who can align your investment goals with your long-term financial goals.