Thanks to the longest bull run on record, you’re in the fortunate position of holding a bag of highly appreciated stocks. And if you receive equity as part of your compensation, you might have most of your net worth (and your hopes and dreams) tied up in the fate of one stock.
You know you should be smart and take some money off the table. But who wants to be faced with the certainty of “losing money” to taxes?
My social worker wife reminds me that these taxes will go towards funding much-needed social programs. I’m all for that. But I also know that even with a high income, covering the cost of living in places like the San Francisco Bay Area can be challenging.
In addition to avoiding taxes, you may also be holding on because you’re afraid of missing out if the stock rises, or you may be waiting for the stock to “come back” to a previous high.
But what if the long-term consequence of not selling is actually worse than taking a tax hit now? What if a diversified portfolio can give you a greater probability of building more wealth over time?
You could be right about a concentrated position. But the better question to ask is: How much can you afford to be wrong?
For most folks, financial success isn’t about maximizing returns. It’s about maximizing the certainty that you will be able to afford your most important financial goals.
So here’s a question to ponder: If you lost, say, 50% of the value of your concentrated stock, what would you no longer be able to afford?
If you’re not okay with losing any of these, then it’s time to diversify.
Here’s the thing: The stock market is composed of many losers and a few outstanding winners. And the winners change all the time.
This JP Morgan study posed the question: Over the long-term, how often would you be better off owning cash or the Russell 3000 index versus a single stock?
The answer: 42% of the time, a single stock experienced negative returns which means you would have been better off holding cash. 66% of the time, a single stock performed worse than the index. Only 10% were “mega winners”, generating returns in excess of 500% of the index. And while we’d like to believe that we’d know a good business if we saw one, most companies fail for reasons largely outside of management’s control.
We have clients who come to us with 20%, 50% even 90% of their investable wealth in a single stock. Many of them have strong convictions about their positions. So what’s the right amount to hold?
We answer that question by starting with your goals. A diversified portfolio is your best bet at building wealth at lower risk, while a single-stock position gives you a shot at mega-returns. So think about the important goals that you’d regret not funding, and that will help you decide how much you can leave in a concentrated position as a high risk/high reward bet.
When you shift your focus to your goals – such as funding your kid’s college fund – it alleviates the emotional rollercoaster of watching stock prices. You’re far less likely to feel FOMO if you’ve had the satisfaction of securing your kid’s future by taking some chips off the table.
Sell now and diversify.
This is the most straightforward action, but it’s important to understand the tax implications. Look for opportunities to harvest tax losses elsewhere to offset gains from a sale (don’t forget your crypto account). Given Biden’s tax proposals, this may well be the year to realize gains before tax rates change.
Come up with a plan to systematically sell over time.
This may be based on achieving certain price points, time period, or personal events (e.g. when you leave the company). You may also choose lots based on cost basis in order to optimize for taxes. The main benefit is to manage price risk and spread capital gains over time. During the time that you’re still over-exposed to a position, it’s important to look at how the rest of your portfolio is constructed. As example: If a stock correlates highly with its industry, we may consider adjusting weighting for that industry in the rest of the portfolio to reduce overall risk.
If your stock is coming from RSU compensation, start by taking that off the table.
RSUs are taxed as ordinary income at vesting, just like your paycheck. So if your employer had handed you cash instead of RSUs, would you turn around and buy company stock? If the answer is no, consider selling immediately. If you do that, the sale should have no tax implications. You may be able to set things up so that RSUs automatically sell at vest.
Give it away (with less going away to taxes):
When you donate appreciated stock to charity, you can avoid incurring capital gains tax (thus giving more) while receiving a tax deduction. Doing this through a Donor Advised Fund may be even better because a large transfer of stock can be made to the DAF at once (with you receiving the deduction in that year), while distributions to charities can happen over many years in the future.
If you’re unable to divest for whatever reason, there are other options to manage a concentrated position.
Examples include using an exchange fund to diversify without selling, using hedging techniques like “collars” to reduce risk, and transferring funds to charitable or family trusts to optimize for taxes and move the stock out of your estate.
We all want to optimize our wealth. And a big part of my job as a financial planner is helping clients do just that.
But the most important question isn’t “should I sell my stock?” or “how much and when?.” It’s a more existential one: “What do I want my money to do for me?”
My concentrated stock positions helped accelerate our family along the path of financial freedom. We’ve since sold most of it and reinvested systematically into a diversified portfolio – this gave us the financial security to leave salaried security, take our family around the world, and work on stuff we care deeply about like this charity bike ride benefitting LGBT freedoms in Asia.
This makes sense for us because what we want from our money is to keep enabling us to live the life that we have right now.
Money is just a means to fuel your best life, and its value lies in the freedom you have to do what you love the most. So what does your best life look like? Answer that, then work backward to figure out what you need from your money to make that happen.
We specialize in life-centered financial planning for LGBTQ and other modern families who want the freedom to choose their own adventure. Like ourselves, many of our clients come from careers in tech and public service. Schedule a free money strategy session with me here.