What is a Concentrated Stock Position?
If equity compensation (i.e. RSUs, ISOs, NSOs, ESPP) is a part of your employer benefits package, you’ve inherited a stock that’s skyrocketed, or you made a lucky bet on a company’s IPO, chances are your portfolio may develop a concentrated stock position.
Typically, we consider a security to be concentrated when it makes up 10% or more of your overall investment portfolio (this excludes the value of your home). Note that we mean single stocks only and not 10% or more in a diversified ETF or mutual fund. When this happens, your wealth can become more at risk compared to a properly diversified portfolio. Of course, there’s the argument for having a concentrated position by those who have benefitted from one. For example, buying and holding Apple or Microsoft since their IPO. However, as we know, past performance is not indicative of future performance and gambling with your life’s savings is not the most prudent.
For advisors, there are several reasons why we become concerned when we see this in your portfolio. Think back to the global financial crisis and how quickly the markets can change. Had you held all or a large portion of your assets in any one company, you could have experienced significantly greater losses and taken longer to recover compared to a diversified portfolio. The reason being, there are many facets to the market – domestic, international, equities, fixed income, small-cap, etc. and each of these are affected differently with changes in the financial landscape. Add to that the fact that no one can predict who will be the next Enron or Blockbuster and the argument for diversification prevails. So, although you may not experience 100% of the upside with a market shift, you won’t experience 100% of the downside either. Successful investing involves taking calculated risks to minimize losses and maximize gains.
So, what can you do if you have a concentrated position? We recommend diversifying out of it in a tax-efficient manner until it is below 10% of your overall portfolio, ideally 5% or less.
The obvious way in which to do this is sell some of the stock. Typically, we’d need to do this over multiple years to minimize taxes, and if your concentration comes from employer equity compensation then it will most likely be a yearly tactic. Together, we can create a yearly “tax budget” wherein you’re willing to realize a certain number of gains, for example $100k to diversify out of this position. Some other considerations would include AMT thresholds and avoiding climbing into the next highest tax bracket.
Another option is donating the appreciated stock adhering to the annual gift tax exclusions or creating a Donor-Advised Fund (DAF). With a DAF you receive an immediate tax benefit in the year you place the stock in the DAF, and you can make grants to charitable organizations of your choice over time. If you work for a company like Apple, they even have a Matching Gifts program where under certain parameters they’ll match your Apple stock donation!
The best option for you may be a combination of these and hopefully, you’ve learned that while this may be a good problem for you to have it’s best not to wait to take action to protect your hard-earned wealth! Remember that your portfolio isn’t simply a number but a means to provide you the lifestyle you want. Properly diversifying to fulfill your current needs while ensuring the longevity of your assets can help you to rest easy at night knowing you can weather the next financial storm.
