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Balancing the Risks & Rewards of Concentrated Stock in your Portfolio

By Jonathan Rosner, Wealth Advisor

Year in Review: Evaluating Portfolio Risk and Concentrated Stocks

As with many things, the end of a calendar year is a great time to review the state of your investment portfolio. Conventional investing wisdom dictates that a well-diversified portfolio can be paramount in reaching your long-term financial goals while minimizing risk over time. By spreading investments across various asset classes, industries, and regions, an investor is effectively using risk management safeguards to help balance the risk and reward trade-off inherent to any one specific asset. However, some investors find that a significant portion of their portfolio is concentrated in a single company stock, a risky position that can either make you a lot of money, or ruin your financial plan.

Concentrated stock can generate a great deal of wealth, often allowing executives and employees to enjoy the success of their company’s business. But, concentrated stock can also be a significant risk to an individual’s long-term financial plan. In contrast to the measured risks associated with a well-diversified portfolio, an investor with a highly concentrated stock position is vulnerable to the fortunes of one single company. Developing an investment plan that lowers your risk profile while maximizing your returns must take into account your long-term financial goals. Often, these goals conflict with the higher risk associated with holding such concentrated stocks.

Here we will consider developing a sound strategy for concentrated stock that aligns your investment portfolio with your long-term financial goals.

Strategy 1: Rolling Sale of Concentrated Stock

If you are concerned about having a considerable amount of your portfolio tied up in one company, yet wish to retain some upside appreciation potential, the rolling sale of your concentrated stock is a good strategy. Put simply, this strategy involves selling the stock on a rolling basis, either in a stated portion, percentage, or number of shares over several years. Also called “staged selling,” many investors are drawn to this strategy for tax purposes. Rather than sell all of your concentrated stock in one large sale, which would trigger a potentially massive tax event, depending on the stock type and how long you have owned it, a rolling sale strategy spreads the tax impact on your returns over many years and allows for more effective cash flow planning, helping to ultimately create a more accurate financial plan.

Strategy 2: Donating to Charity or Gifting

For an investor interested in reducing their income taxes on their annual tax return, donating the proceeds from concentrated stock to a charitable organization is an effective strategy. Any monetary gift to a charity provides the donor with a tax deduction. But, before you sell off your assets and donate the proceeds to charity, consider how to maximize your donation.

Planning to sell a highly appreciated stock for the ultimate goal of a charitable donation may not be the most cost-effective form of giving. The capital gains of your asset will still be subject to taxation before you give the proceeds to charity – effectively lowering the value of the gift by forfeiting some of the proceeds to Uncle Sam.

Provide the recipient organization the most value by gifting the actual stock shares to the charity directly, or by contributing the shares to a donor advised fund where you can issue grants to various charities until the funds are exhausted. This option is more valuable for both parties: the charity will receive the full value of the gift while the donor gets their full tax deduction. Thanks to the tax classification of charities, the organization receiving your concentrated stock could sell the shares themselves with no tax liability! (Note: this option does not cheat the IRS out of tax revenue. Instead, it merely maximizes the value of your gift for the charity and for your tax deduction).

Additional Concentrated Stock Strategies and Who They Might Suit

Additional strategies for managing concentrated stock exist, but they may come at a higher price or add unnecessary complexity to your plan. However, depending on your circumstances, these strategies are viable options for maximizing your wealth.

Implement an Equity Collar – one of the more common hedging strategies for concentrated stock holders, this involves buying (going long) a put-option on the stock while simultaneously selling (going short) a call option on the stock, with both contracts being equal in duration. Without getting too technical, this strategy effectively creates a structure that provides downside protection and upside potential. This approach would work best for a high net worth investor that is focused on preserving value, is uncertain about the stock’s future, and is willing to pay higher fees to put the structure in place.

Create Exchange Funds – an option that is more suitable for accredited investors, this strategy is also known as a pooled fund. This strategy is built on the concept that there are a number of investors in the same position as you but with the stock of a different company. Generally speaking, the investors pool a set amount of shares into a partnership, and each investor receives a pro-rata share of the partnership’s return. More often than not, this strategy is for an accredited investor who meets specific net worth and income criteria, and the investor is prioritizing tax deferral over fees and risk.

Making your Concentrated Stock a Key Pillar of your Financial Plan

The reality is that a portfolio can live with concentrated stock. But aligning your investment portfolio with your long-term financial goals and objectives may require that you maintain a low risk profile. The risk-reward tradeoff of holding concentrated stock may not add up for your life aspirations. Use the strategies above to help reduce your risk profile and maximize your chances of reaching your long-term financial goals and objectives.

As a company, Bronfman Rothschild employs goals-based investing strategies. We design investment portfolios that are in line with your personal goals, your financial timeline, and your risk tolerance. Maintaining concentrated stock can be very beneficial in certain cases, but it is inherently risky when not done properly. Therefore, concentrated stock must be viewed holistically – that is, within an individual’s larger investment strategy and long-term financial goals. For a holistic view of your investment portfolio, consult a trusted financial advisor who can align your investment goals with your long-term financial goals.

Note: This post was amended on 12/27/17 to reflect the final version of the Tax Cuts and Jobs Act that was passed into law.

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This information should not be construed as a recommendation, offer to sell, or solicitation of an offer to buy a particular security or investment strategy. The commentary provided is for informational purposes only and should not be relied upon for accounting, legal, or tax advice. While the information is deemed reliable, Bronfman E.L. Rothschild, LP cannot guarantee its accuracy, completeness, or suitability for any purpose, and makes no warranties with regard to the results to be obtained from its use. Past performance does not guarantee future results.
Bronfman E.L. Rothschild is a registered investment adviser (dba Bronfman Rothschild). Securities, when offered, are offered through an affiliate, Bronfman E.L. Rothschild Capital, LLC (dba BELR Capital, LLC), Member FINRA/SIPC. © 2017 Bronfman Rothschild

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