Advising Investors with Concentrated Stock Positions

Financial advisers can offer multiple strategies to help investors with concentrated stock position reduce portfolio risk and tax burdens.
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Financial advisers often emphasize the benefits of portfolio diversification to clients. While you don’t want them to go overboard and have too many holdings, diversification can pay off in reducing investment risk.

Sometimes clients end up in the opposite situation of having a concentration in one or two stock positions. If the stock happened to be Apple  (AAPL) - Get Report or Amazon  (AMZN) - Get Report and they are long-time shareholders, that has turned out well for them, but the risks for the future still remain. Clients need your guidance in dealing with concentrated stock positions to help them mitigate the potential risks.

An investor can end up with a concentrated stock position for many reasons. These can include:

  • An inheritance. Perhaps they inherited a large number of shares for a parent or other relative. 
  • They might be a long-term shareholder of a company whose stock has appreciated greatly over time. These long-term investors have benefited from the classic advice of buying low. The appreciation of the shares may have led to these shares representing an inordinate percentage of their overall portfolio. 
  • A concentrated position can arise for a client who is an employee of a company who offers stock based compensation such as stock options or restricted stock units. This might also arise if the company uses its shares for an employer match or profit sharing contribution for employees in their 401(k) plan.

Emotional Attachment

One issue that sometimes occurs with investors who have held a stock for a long time and have seen the stock appreciate many times over from their original cost, is an emotional attachment to the stock. They’ve held it this long and done well. Why wouldn’t this continue?

Depending upon the client and your relationship with them, they may listen to your arguments about why it makes sense to at least reduce their concentrated position a bit. Whether they listen or not, it is still incumbent upon you to continue to have this discussion with them assuming you believe they should diversify away from their concentrated holdings.

Reducing Concentrated Positions

Depending upon your client’s situation, there are several strategies to reduce concentrated positions.

In the case of a client receiving restricted stock units that add to this concentration, those new positions can be sold off in the year received with little or no additional tax hit. Since RSUs are taxed when they vest, it would make sense to sell these new shares and use the proceeds to diversify your client’s portfolio into other holdings.

If some of the shares are held in an IRA account, there is no current year tax consequence on any realized gains. The proceeds can be reinvested elsewhere, and the money can continue to grow tax-deferred (or tax-free in the case of a Roth IRA) until money is distributed from the account in retirement.

If the client recently inherited a large number of shares in this stock, this may be a good time to sell some of those shares to attempt to pare back this position. Shares that are inherited receive a step-up in cost basis which may mitigate or eliminate any tax hot on the sale for your client.

For shares held in a taxable account, you might work out a gradual plan to reduce the percentage of the shares in their client’s overall portfolio over time. Assuming the shares have been held for at least a year, any capital gains on sales of the shares will be taxed at preferential long-term capital gains rates. If during the year other securities are sold at a loss, those losses can be used to offset any gains on selling shares of the concentrated holding.

For clients who are charitably inclined, the shares be donated to a charity or to a donor advised fund. Donating appreciated securities allows your client to avoid paying any capital gains taxes. If the client can itemize deductions, they would receive a charitable deduction as well.

Shares can be used to make gifts to family members. Each person can make a $15,000 annual gift to anyone they choose. Additionally, the current lifetime gift and estate tax exemption is $11.58 million per person so gifts in excess of the $15,000 can be made free of tax. If you are gifting the shares to a family member in a lower tax bracket this can be a very effective wealth transfer strategy.

Use stop orders on some of the shares to put a floor on any decline in value. Stop and related types of orders can limit the downside on the shares.

Overall, work with clients who have concentrated stock positions to find the best way to reduce that concentration. Planning is key. But it’s also important to discuss the need to reduce these concentrated positions with your clients to get their buy-in to this strategy.