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Holding a Concentrated Stock Position? Strategies to Mitigate Risk

The allure of a stock that skyrockets in value can be intoxicating. However, holding a large position in a single company, a concentrated stock position, exposes your portfolio to significant risk. Imagine all your eggs in one basket – if the company falters, your entire portfolio suffers. Fortunately, there are strategies you can employ to diversify your holdings and spread that risk.

What Exactly is a Concentrated Stock Position?

A concentrated stock position is when a significant chunk of your investment portfolio—often thought of as 10 % or more—is tied up in a single company’s stock. There are many ways to end up with a concentrated stock position, such as inheriting shares, receiving equity-based compensation from your employer, or simply investing heavily in one particular company.

Here are some key strategies to diversify a concentrated stock position:

Gradual Selling and Strategic Reinvestment

The most straightforward approach is to gradually sell a portion of your concentrated holding and reinvest the proceeds into a diversified portfolio. This allows you to capture some of the gains from the stock while mitigating risk. Here’s how to approach this:

Develop a selling schedule: Determine a set amount or percentage of your holdings to sell at regular intervals. This could be weekly, monthly, or quarterly, depending on your comfort level and the stock’s volatility.

Choose diversification targets: Based on your risk tolerance and conversations with your advisor, invest the proceeds into a diversified asset allocation.

Potential tax implications: Consider the tax implications of selling. If the stock has appreciated significantly, you may incur capital gains taxes. Consult with a tax advisor to understand your tax liability and explore strategies to minimize it.

Tax-Advantaged Gifting

Gifting a portion of your concentrated stock position to family members or charitable organizations can be a win-win strategy. It reduces your portfolio concentration and potentially offers tax benefits:

Family gifting: Gifting shares to family members allows you to gradually transfer wealth while potentially reducing your estate tax burden. Annual gift tax exclusions will enable you to transfer a certain amount of assets tax-free. Consult with a tax advisor to understand the current limits and potential tax implications.

Charitable donations: Donating appreciated stock to a qualified charity allows you to deduct the full fair market value of the stock from your taxes, potentially reducing your tax liability. Consult with a tax advisor to understand the current limits and potential tax implications.

Utilizing Options Strategies 

Options contracts offer more complex strategies for experienced investors to hedge their existing positions or generate income. Here are three common methods, but remember, these may involve significant risk and require a thorough understanding of options:

Selling covered calls: You sell call options on your stock, granting the buyer the right to purchase your shares at a specific price by a certain date. If the stock price rises and the option is exercised, you are obligated to sell your shares at the predetermined price. By selling the covered call options, the seller is able to generate income.

Buying put options: This strategy helps protect your downside risk. Put options give you the right to sell your shares at a specific price by a certain date. If the stock price falls significantly, you can exercise the put option and sell your shares at the predetermined price, limiting your losses.

Collar: This strategy is a combination of both selling a covered call and buying a put option.  In theory, the income received from selling the covered call allows the investor to pay for at least some of the cost of the put option.

Exchange Funds

Exchange funds allow for diversification from a concentrated stock position into units of a more diversified pool of securities, an Exchange Fund  (Note: exchange funds are different vehicles from exchange traded funds, or ETFs).   There may be differences among exchange funds but it is expected that investors must be qualified purchasers (QPs) in order to participate.  In addition, the exchange fund must have capacity to accept the particular security the investor is looking to diversify away from.  Also, it is strongly suggested to speak with a tax professional to fully understand any tax consequences.

Separately Managed Account (direct indexing)

The use of a separately managed account (SMA) is another way to help diversify away from a concentrated stock position.  For example, with direct indexing (the SMA is the investment vehicle used), the investor would hold a number of individual stocks that aim to replicate a particular index.  Through holding the individual stocks, the investor would be able to sell any of the stocks that have losses and use those losses to offset any capital gains from selling the concentrated stock position. Consult with a tax advisor to understand the current limits and potential tax implications.

Holding and Managing Around the Concentrated Position

If you have a firm conviction in the long-term prospects of the company, you might consider holding onto the stock while building a diversified portfolio around it:

Focus on core portfolio construction: Invest in a diversified mix of assets based on your risk tolerance and time horizon. This could include a combination of index funds and actively managed mutual funds and bonds.

Rebalance periodically: Over time, the weightings of your assets will inevitably shift. Regularly rebalance your portfolio to ensure it aligns with your target asset allocation.

Monitor your overall risk profile: While the concentrated position remains, monitor its impact on your overall portfolio risk. Consider adjusting your diversification strategy if the concentrated position becomes a disproportionately large share of your portfolio.

Step-up in cost basis: Finally, if you hold the security until your death, the cost basis of the security receives a “step-up” in cost basis for those inheriting the asset, potentially reducing capital gains exposure.

East Bay Investment Solutions cannot provide tax advice and would recommend speaking with a tax professional before implementing any of these possible solutions.

East Bay Investment Solutions, a Registered Investment Advisory firm, supplies investment research services under contract.

This document contains general information, may be based on authorities that are subject to change, and is not a substitute for professional advice or services. This document does not constitute tax, consulting, business, financial, investment, legal or other professional advice, and you should consult a qualified professional advisor before taking any action based on the information herein. This document is intended for the exclusive use of East Bay clients, and/or clients or prospective clients of the advisory firm for whom this analysis was prepared in conjunction with the EAST BAY TERMS OF USE, supplied under separate cover. Content is privileged and confidential. Information has been obtained by a variety of sources believed to be reliable though not independently verified. To the extent capital markets assumptions or projections are used, actual returns, volatility measures, correlation, and other statistics used will differ from assumptions. Historical and forecasted information does not include advisory fees, transaction fees, custody fees, taxes or any other expenses associated with investable products unless otherwise noted. Actual expenses will detract from performance. Past performance does not indicate future performance.

The sole purpose of this document is to inform, and it is not intended to be an offer or solicitation to purchase or sell any security, or investment or service. Investments mentioned in this document may not be suitable for investors. Before making any investment, each investor should carefully consider the risks associated with the investment and make a determination based on the investor’s own particular circumstances, that the investment is consistent with the investor’s investment objectives. Information in this document was prepared by East Bay Investment Solutions. Although information in this document has been obtained from sources believed to be reliable, East Bay Investment Solutions does not guarantee its accuracy, completeness, or reliability and are not responsible or liable for any direct, indirect or consequential losses from its use. Any such information may be incomplete or condensed and is subject to change without notice.

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