Understanding your options for a concentrated stock position
There are different reasons why you may find yourself with a concentrated stock position. Perhaps you received shares through an inheritance or accumulated company stock through compensation. Or maybe you watched as one of your holdings appreciated until it became a disproportionately large part of your portfolio.
Your success may have played a large part in creating this situation, but having a portfolio built around one or a small handful of stocks can bring both emotional and practical challenges. Concerns about the tax implications of selling, fear that you might miss out on further gains, or even a personal connection to what the stock represents can make it difficult to make changes. While having a concentrated stock position does not mean you have done anything wrong, it can potentially expose your portfolio to additional risk.
What exactly is a concentrated stock position?
A concentrated stock position occurs when one stock, or a small number of individual stocks, represents a disproportionately large share of your investment portfolio. This can happen intentionally, but it can also develop gradually when a particular stock performs well over time and grows to represent a much larger percentage of the portfolio than it once did.
There is no single percentage that defines a concentrated position for every investor. What matters is whether the size of the holding creates enough exposure that a significant change in the value of one company could have a meaningful impact on your overall portfolio and financial plan.
What are my options if I have a concentrated stock position?
1. Hold the stock
You can choose to maintain your current position for a few different reasons.
- You may have confidence in the company.
- There might be restrictions associated with employer stock.
- There could be estate planning considerations.
Your financial advisor can help you review your specific portfolio and the factors involved in your case to determine whether continuing to hold the stock may be appropriate. While having confidence or conviction in a particular company may be one reason to continue holding it, doing so does not eliminate the concentration risk created by having a significant portion of your portfolio invested in a single company.
For example, if one stock represents 40% of your portfolio and its value declines by 50%, your overall portfolio would decline by approximately 20% from that holding alone, even if every other investment remained unchanged.
Diversification can help reduce concentration risk, but it cannot eliminate systematic risk associated with broader market movements. Holding the position may allow you to participate in potential future growth and, in a taxable account, avoid realizing capital gains associated with a sale. However, continuing to hold a significant position means accepting the company-specific concentration risk that comes with that decision.
2. Sell some or all of the stock
Selling some or all of a concentrated stock position and reinvesting the proceeds in a more diversified portfolio is a direct way to reduce concentration risk. However, the potential tax consequences should be considered as part of the decision.
- If the stock is held in a tax-advantaged retirement account, selling does not create an immediate capital gains tax liability within the account.
- In a taxable account, selling appreciated shares may result in capital gains taxes.
Depending on the circumstances, your advisor may recommend reducing the position gradually by selling shares over multiple tax years rather than selling the entire position at once. This may help spread the realization of capital gains across multiple tax years rather than concentrating those gains in a single year. Capital losses from other investments may also help offset some of the gains realized as shares are sold.
Another option may be to direct new investments toward other holdings rather than immediately selling the concentrated position. Over time, this can reduce the percentage of the portfolio represented by a single stock while increasing diversification.
3. Gift shares
Gifting shares may include charitable giving or gifts to family members.
- Charitable giving – Donating appreciated stock directly to a qualified charity can allow you to support an organization that is important to you while also reducing the size of a concentrated position. When certain requirements are met, you may be able to avoid realizing the capital gain that would have resulted from selling the shares yourself and may also qualify for a charitable deduction.
- Family gifting – You can also gift shares to family members, but the tax implications should be carefully considered. In general, the recipient receives your cost basis in the shares and may be responsible for capital gains taxes when the stock is eventually sold. By contrast, inherited shares generally receive a step-up in basis to their fair market value at the owner’s death. Depending on the amount of appreciation involved, that difference can be significant and should be considered as part of your broader estate plan.
4. Hedge the position
There are strategies that can potentially help protect against some of the risk associated with a concentrated stock position without requiring you to immediately sell the shares. However, these strategies can be complicated, involve additional costs, cover limited periods of time, and have tax implications.
Some strategies that may be considered include:
- Protective puts – Purchasing a put option can give you the right to sell shares at a predetermined price for a specified period of time, potentially limiting losses if the stock price falls. The protection comes at a cost in the form of the premium paid for the option.
- Collars – A collar generally combines the purchase of a protective put with the sale of a call option. The put can provide some downside protection, while the premium received from selling the call may help offset the cost of purchasing the put. In exchange, however, the call can limit how much you benefit if the stock price rises above a certain level.
Hedging strategies may be appropriate in certain situations, but because of the complexity, costs, and potential tax implications involved, it is important to work with your financial advisor and tax professional to determine whether this type of strategy is appropriate for you.
One size does not fit all
If you have a concentrated stock position, there may be several ways to reduce risk and create greater balance in your portfolio. You do not have to keep everything or sell everything. A plan could involve holding some shares, selling some over several years, donating highly appreciated shares, and potentially hedging another portion.
The appropriate combination depends on your goals, tax situation, time horizon, risk tolerance, charitable intentions, and the reason you own the stock in the first place. Your financial advisor can help you evaluate the tradeoffs and develop a strategy that fits within your broader financial plan. If you are concerned about a concentrated stock position and would like to learn more about your options, please contact us.