At Mission Wealth we’ve helped manage hundreds of concentrated stock positions for our clients. Many investors have large, concentrated stock positions within their portfolios. For one reason or another, investors can be hesitant to sell these positions. More often than not, it’s due to the tax consequences of realizing substantial gains, but in other instances there may be sentimental value attached to the position.
Even if the stock has done well, an investor’s financial plan may warrant more diversification, or there may be new financial goals that require a shift in strategy.
Watch the video and read more below.
Why is diversification so important?
Data shows that an individual stock has significantly more risk of loss than a diversified portfolio with many positions.
For instance, from 1980 through 2020, approximately 44% of all stocks experienced a catastrophic loss – that is a price decline of 70% or more from peak value, with minimal recovery.
Over the same timeframe, 2/3rds of all stocks, or 66%, underperformed the broad stock market.
For investors with concentrated positions, diversification and downside protection should be a central consideration within an overall financial plan.
Diversification away from single stock exposures may help reduce risk and lower volatility, while at the same time providing exposures to a broader range of stock exposures and different asset classes that may offer attractive risk-return profiles.
What are your options to address a concentrated stock position?
- You could do nothing and assume the concentrated stock risks previously outlined.
- You could sell the position and realize taxes if held in a taxable account. Importantly, we can manage these sales over the course of multiple tax years to help smooth the tax implications.
- You could utilize a Custom Options Strategy to create downside protection. This strategy may also combine tactical divestment of the position each tax year.
- You could also use an exchange fund to initiate a tax-free swap and immediately diversify into a limited partnership pool that seeks to replicate returns of the broad stock market.
Customized Options Strategies
Customized options strategies can include buying a Put Option on the underlying stock, which provides downside protection similar to insurance.
An Options Collar is an investment strategy used that utilizes both call and put options to keep the returns of the concentrated stock range bound. By selling Call Options to fund the purchase of Put Options, this strategy has the potential to be implemented in a costless manner. Learn more about The Importance of Managing Investment Costs.
Laddering options collars with expiration dates spanning different tax years may allow us to tax efficiently sell down a set amount of concentrated stock over time. Explore some of the recent Tax Reform and Legislation with Mission Wealth's Director of Tax Strategy.
An Exchange Fund
An Exchange Fund allows for the contribution of a single stock into a diversified pool of stocks. This diversified pool is constructed to closely track the returns of the broad stock. Importantly, the contribution of a highly appreciated stock into an exchange fund is not a taxable event; unlike selling the stock and realizing the gains, the contribution of a stock into an exchange fund does not trigger any realized gains and investors maintain their original cost basis.
After seven years, the investor can receive back a diversified basket of stocks with no capital gains consequences. To participate, an investor must be a Qualified Purchaser; your client advisor can help you determine if you meet these requirements. Learn more about The Benefits and Advantages of Global Diversification.
How Mission Wealth Can Help
MISSION WEALTH IS A REGISTERED INVESTMENT ADVISER. THIS DOCUMENT IS SOLELY FOR INFORMATIONAL PURPOSES, NO INVESTMENTS ARE RECOMMENDED. ADVISORY SERVICES ARE ONLY OFFERED TO CLIENTS OR PROSPECTIVE CLIENTS WHERE MISSION WEALTH AND ITS REPRESENTATIVES ARE PROPERLY LICENSED OR EXEMPT FROM LICENSURE. NO ADVICE MAY BE RENDERED BY MISSION WEALTH UNLESS A CLIENT SERVICE AGREEMENT IS IN PLACE.