Managing Concentrated Stock Positions
Concentrated stock positions can build wealth, but they can also destroy it. The recent performance of technology stocks and crypto assets is a great example: many investors’ concentrated positions lost significant value or became effectively worthless, in some cases overnight. Below I explore the benefits and risks of concentrated stock positions and how to build a plan to sell or diversify a large stock position.
How do you get a concentrated stock position?
Do you hold a concentrated stock position, or are you uncertain how to plan for an event that may result in holding a large stock position? There are many common ways that individuals and families end up with large positions in a single stock.
There are many ways that investors can end up with large positions in a single holding, including:
Equity compensation from employer
Business owner post-exit
Being the trend (e.g., Crypto)
Inheritance
Equity Compensation
Large equity compensation grants often lead to concentrated stock positions. Receiving stock options or restricted stock units (RSUs), participating in an Employee Stock Purchase Plan (ESPP), or getting a signing bonus in stock can all build large, concentrated positions.
Many executives are bullish on their company’s prospects. This often leads to maintaining concentrated positions on the belief that stock will continue to rise in the long term.
Business owner post-exit
Some business owners receive some or all of their sale proceeds compensation in the form of the purchasing company’s stock.
Given differing lockup periods and market conditions, these concentrated positions can create logistical, emotional, and financial headaches.
Buying the Trend (e.g., Crypto)
Buying into a hot trend (e.g., tech stocks in the 2010s or Crypto in the 2020s) can result in a rapidly rising portfolio and a huge amount of wealth creation within highly concentrated positions.
These large stock positions may present the highest degree of risk, as they are often unstable asset classes and prone to stunning collapses with a small, or no, amount of warning.
Inheritance
Inheritors don’t just receive the concentrated stock or other asset positions that their family hands down. Often, they also inherit a complex web of emotions and experiences tied to those positions.
Managing an inherited position of concentrated stock is often complicated by feelings about the origin of generational wealth and emotional attachments or aversions to the large stock positions in question.
Risks and rewards of large stock positions
Owning a concentrated stock position without diversifying generally ends up in one of two ways: (1) gaining significant wealth or (2) losing significant wealth. When your wealth is tied up in a single asset, your fortunes rise and fall depending on that company’s performance and perception within the market.
Many individuals and families who own concentrated stock positions end up losing significant wealth in companies that most of us have never heard of. But the stories we hear are of people who gained wealth because they held positions in (former) media darlings such as Meta, Amazon, Tesla, Crypto, et cetera.
When your wealth is tied up in a single asset, your fortunes rise and fall depending on that company’s performance and perception within the market.
Risks of Owning a Concentrated Stock Position
Diversification is a key way to protect your portfolio against market swings and the volatility of individual stock positions.
Failing to diversify out of a concentrated stock position opens the door to a large portion of your wealth being wiped out overnight if the company in question fails to perform as expected.
Rewards of Owning a Concentrated Stock Position
If the company in which you hold a concentrated position significantly outperforms the market, it can lead to a huge growth in wealth.
This is the story of many of the tech millionaires that were made over the past decade.
Strategies for concentrated stock positions
Many people who hold concentrated stock positions aren’t ready to sell out of them all at once. This is a valid decision that needs to be made with a full understanding of the benefits and risks involved and with an individual’s personal risk tolerance taken into consideration. It’s easy to avoid diversifying a concentrated position when the markets are running hot and everything is going up. The key to creating a strategy to manage and diversify concentrated stock positions is a realistic accounting of how you would feel if the markets took a turn and your position lost a huge portion of its value.
There are three main strategies for managing concentrated stock positions:
Diversify all at once
For those who received a concentrated stock position in one fell swoop, are leaving a company, or are for whatever other reason, ready to divest from their concentrated stock position, diversifying all at once may be an appropriate strategy.
While diversifying all at once reduces the risk exposure in your portfolio, it may also open the door to a large tax exposure. This method should be undertaken in conjunction with a financial advisor and a CPA who can work together to make sure that your long-term financial goals are being served by any plan to sell a large amount of stock at once.
2. Diversify over time
Those with a higher risk tolerance may choose to maintain a set percentage of their total net worth within a concentrated stock position and build a plan to diversify the remainder of their position over time.
The greatest challenge to diversifying over time is the human element. If you have committed to selling 5% of a concentrated position every 6 months, it can be difficult to pull the trigger if the stock is down (“let’s just wait for it to go back up”) or if the stock is up (“let’s wait for it to go higher”).
This strategy requires a high degree of discipline and, often, the guidance of a financial advisor to remind you of your long-term goals and help navigate the emotional issues associated with diversifying a large stock position.
3. Ride the wave and accept the consequences
Many investors choose to do nothing with concentrated stock positions and roll the dice on where the market takes them. This strategy can generate huge levels of wealth or leave you holding a large amount of worthless stock.
Those who are committed to holding a large percentage of their net worth in a single stock should take the time to fully evaluate the impact on their life and future financial health if the stock were to take a 50% or 100% drop from which it would never recover. “It’s going to keep going up” is not a basis for sound decision making where an investment portfolio is concerned.
Tax Consequences and Tax Strategies for Large Stock Positions
If you hold a concentrated stock position with a low cost basis, odds are you are going to have to pay taxes on it. Your other options are to give the stock away to charity or die holding the full value of your concentrated position and let your inheritors take advantage of the step-up in basis.
Owning a concentrated stock position with a low tax basis can create headaches. Working with a CPA and financial advisor to explore options to mitigate this tax burden is always a wise idea.
Options for those looking to sell a large stock position with a low tax basis include:
Space out the sale over multiple tax years
Spacing out the sale of a concentrated stock position over multiple tax years may allow you to avoid reaching your highest tax bracket and save money in the long run. The risk with this longer-term strategy, however, is that your holdings will decrease in value and negate whatever tax savings you might have achieved.
Consider individuals who partially sold concentrated positions in 2021 and were planning to sell the remainder and finish diversifying in 2022. Unless they sold in very early January, they likely took a haircut on those positions that may have fully wiped out any tax savings.
2. Gift stock to family members or friends who are in a lower tax bracket.
Those with charitable intentions may choose to gift stock to friends or family who can sell it in a lower tax bracket. This does not include gifting stock to be sold to your own children or dependents, who will have the majority of that sale taxed in your highest tax bracket due to the IRS’ “kiddie tax” rules. It is a good option for stock that you would like your children to hold onto long-term.
In 2022, gifts of $16,000 or less ($32,000 or less if you are splitting gifts with your spouse) can be made to any individual without any tax consequences. Larger gifts must be reported from the IRS and will be subtracted against your lifetime gift exemption amount. This is not an issue for most individuals and families, as the lifetime gift exemption amount is currently set at just over $12 million for an individual or $24 million for a married couple.
3. Use charitable giving strategies to create positive impact with your wealth
When building a concentrated stock strategy there are many ways to create a positive impact with your wealth that may also reduce your tax bill. Donating stock to a favorite charity, creating a Donor Advised Fund, or opening a Charitable Remainder Trust may all be good options depending on your preferences and the amount you have to give.
While plans involving charitable giving tend to involve more legwork at the outset and generally require coordinating with your financial advisor, CPA, and possibly an attorney, they provide an opportunity for an individual or family to give back to their community and use their wealth to support those around them.
4. Biting the bullet and paying your taxes
Financial advisors and CPAs don’t say it enough, but there is a fourth option. This option isn’t for everyone, but it has merit and deserves to be recognized. If you believe that:
Capital gains tax rates are highly preferential to wealthy individuals
Paying taxes is an essential part of the social safety net
Government services are essential to the functioning of a fair, democratic society
Although you might not always agree with the government, a society that pays its fair share of taxes is a better place to live
You may want to sell your full concentrated position now, reserve money to pay your tax bill, and go about living your life!
While no one likes a huge tax bill, paying taxes is part of the game and, as we often say “a good problem to have.”
Managing Emotions when creating a concentrated stock strategy
The technical aspects of what to do with large stock positions are relatively straightforward, but the emotional piece is much harder to handle. Investors often get tripped up by the emotional hurdles of divesting from a concentrated stock position, whether that position is inherited or not.
Pulling the trigger to diversify a concentrated stock position can be a difficult question to navigate alone. Setting aside the emotional attachment an investor may have to a company that played an important part in their family’s legacy or helped build their career, human psychology does not make it easy to part with an asset that has helped to build your wealth:
When the market is down, the temptation is to “wait until the stock price comes back up” to start executing a strategy to diversify a concentrated stock position
When the market is up, the temptation is to “wait until the stock price is just a little higher” to start diversifying a large stock position.
Working with a trusted financial advisor who has navigated these waters before and can remind you how diversifying fits into your long-term plans is essential to avoiding the “what if” games that can take place both before and after diversifying a large stock position.
While it can be straightforward, selling a concentrated stock position is more often a logistically complicated and emotionally taxing endeavor. For help building a plan to manage large stock positions in a way that aligns with your goals and vision for your financial future, Contact Katherine or schedule a call to build a strategy that works for you and your family.
About Sunnybranch Wealth
Sunnybranch Wealth is a boutique, fiduciary, fee-only financial advisory firm that works with progressive individuals and families who want to build their wealth while creating positive social impact.
Sunnybranch specializes in working with millennials and busy families who need help but don’t have time or energy to devote to their finances. We serve as your trusted resource and partner, alleviating the stress of managing your wealth and letting you focus on living your life.
Our founder, Katherine Fox, is a CERTIFIED FINANCIAL PLANNER™, Chartered Advisor in Philanthropy®, and 21/64 Certified Advisor with deep expertise and experience in helping clients build wealth while navigating life’s financial challenges. Her work combines comprehensive financial planning, ESG and impact investing, and charitable guidance to serve clients who want to grow their wealth sustainably while giving back in a meaningful way.