Concentrated Stock Position Strategies

By Katy McDonald, CFP® | Apr 22, 2024 |

A concentrated stock position is when an individual holds a significant portion of their wealth in a single stock or a small number of stocks. This can occur due to various factors, such as inheritance, stock options, or a successful investment.  While having a concentrated stock position can be financially rewarding, it comes with risks and challenges.  

Considerations for managing single stock exposure

What percent of your liquid portfolio is invested in a single stock?

Determining the percentage of your portfolio allocated to a single stock is essential for risk management. Consider your age, financial goals, and anticipated cash needs. If you are near retirement, limit concentration risk to preserve capital for upcoming lifestyle needs. Similarly, if you are saving for large purchases, like a house down payment, you want to mitigate risk. Setting a portfolio target of 5% – 20% of liquid assets for company stock can promote discipline and diversification. 

How quickly will a company stock position grow with upcoming vests?

Upcoming stock vests can significantly impact your portfolio allocation. If these vests push your company stock allocation above your target percentage, you must decide how much stock to sell or hold to stay within your desired range. Another thing to consider when determining how much to sell or hold is the tax implications of either decision 

What other exposure do you have to the company?  

Consider your total exposure beyond stock holdings. Do you receive a significant portion of your income from the company in the form of salary or through a deferred compensation plan? Additionally, assess if the company’s activities influence local real estate prices, which can indirectly affect your financial well-being. 

What are the tax consequences of selling an individual stock position?

Selling a single stock can have tax implications, so assessing the exposure to capital gains and applicable tax rates is crucial. Strategically selling high-cost basis shares first can help mitigate tax consequences. Additionally, consider paring down exposure over several years to spread out the tax impact and minimize upfront tax liabilities. 

Strategies for reducing single stock exposure

Single stock exposure can leave you vulnerable to market fluctuations and company-specific events. Diversification is critical to managing risk and ensuring a well-balanced portfolio.  

Here are several strategies for reducing single-stock exposure, each with pros and cons.

#1 Sell 100% of the single stock holding at the current price

Selling all shares at the current price offers a straightforward solution to quickly eliminate single-stock exposure. This de-risks your portfolio, and the proceeds from the sale are known. However, consider the tax implications of selling all shares simultaneously, as capital gains taxes will be due in a single tax year. 

#2 Set a limit order to sell the stock at a specified price

Utilizing limit orders provides a way to capture higher prices while protecting against potential significant losses. This approach may result in excess upside price movement. However, if the stock price doesn’t reach the specified limit, there’s also a risk of missing out on selling. 

#3 Incrementally sell shares on a predetermined schedule

Selling shares gradually over time can spread the tax impact while reducing exposure to a single stock. Market downturns could affect the overall effectiveness of this approach. If the stock price declines, you lose the potential benefit of tax planning. 

#4 Diversify via exchange fund

Exchange funds allow concentrated shareholders to diversify their holdings without triggering immediate tax consequences. Investors receive units of a partnership that owns a broad basket of securities intended to replicate an index. Nonetheless, exchange funds come with eligibility requirements and restrictions that may not suit all investors, including the need for qualified purchasers only and a seven-year lock-up period. 

#5 Write covered calls

The main advantage of covered calls is generating income by writing call options against existing stock holdings. However, this strategy also means forgoing upside stock appreciation while retaining downside risk. The income generated from covered calls may not always be meaningful enough to justify this trade-off. 

 #6 Fund charitable gift account

Donating appreciated stock to a charitable gift account can provide tax advantages while supporting worthy causes. Investors receive a tax deduction for the gifted amount and can avoid paying capital gains taxes, providing a double tax benefit. However, this strategy requires philanthropic intent and involves relinquishing control over the assets for charitable purposes. 

You can also utilize appreciated stock to give gifts to family members. This works because you can transfer the allotted gift amount of $18k to an individual. This is especially beneficial if the individual is in a low tax bracket to liquidate and diversify the gifted stock without a significant tax burden.  

Defining your objectives (preserving wealth, generating income, or achieving growth), assessing your risk tolerance, developing a diversified asset allocation strategy, and monitoring and adjusting over time will ensure your concentrated stock positions align with your objectives.  

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