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How (and Why) to Fix a Concentrated Stock Position

By Jennie Sanders

Maybe you bought Apple stock in the early 1980s after it went public. Maybe you’ve worked at the same company for years, and you’ve built up a (not insignificant) pile of company equity. Maybe an IPO served as your personal jackpot. Or maybe you inherited some stock that has since skyrocketed in value.

How (and Why) to Fix a Concentrated Stock Position

No matter how you got there, if you’ve made a decent chunk of change (or more) thanks to a certain stock in your investment portfolio, you might be resisting the idea of parting with it. After all, hanging on has worked out pretty well for you so far (not to mention those capital gains taxes you’d have to pay if you sold).

So … why should you consider diversifying? Well, concentrated stock may make you rich, but diversification is meant to help you stay that way.

What’s a concentrated stock position?

At Ellevest, we’d say you have a “concentrated” stock position if you have more than 10% of your total investment portfolio in a single stock or company. (Note: we’re talking single stocks only. Having more than 10% in a diversified ETF or mutual fund is different.) Your total investment portfolio includes all your investable assets — that is, all your cash and investments except the house you live in.

So … what’s the big deal?

I started my career in 1999, so I’ve worked in the industry through two significant market downturns. First was the dotcom crash in the early 2000s, when I was working as a portfolio manager at Wells Fargo. I remember listening to retirees who, in early 2000, wanted to sell off the bonds in their portfolios so they could jump on the bandwagon of those “can’t lose” stocks that had “dotcom” after their names.

I got to see firsthand how much better diversified portfolios weathered the downturn.

My job was to advise against chasing returns and remind them that their diversified portfolio had been purposefully designed to meet their goals. You know what happened next: “Can’t lose” turned into “did lose.” I got to see firsthand how much better the diversified portfolios that stayed the course weathered the downturn.

Second was the 2008 financial crisis. At the time, I was working as a senior financial analyst at Merrill Lynch, and I was the dedicated portfolio manager on one of their Private Banking and Investment Group (PBIG) teams. Many of our clients were executives who could only sell their concentrated stock positions during certain windows. For example, restricted stock units (RSUs) can only be sold once they’ve vested, and some executives’ contracts are subject to blackout periods during which they can’t make any company stock transactions.

I worked with these clients to design plans to sell down their concentrated positions in a systematic way. Unfortunately, not everyone had the opportunity to diversify in time. According to a study conducted by J.P. Morgan, about 40% of all Russell 3000 companies have lost at least 70% of their value — permanently — down from their peak since 1980. For technology and biotech companies, that number’s even worse. So my question is this: What would happen if the company you’re concentrated in — Apple, Facebook, whatever — is the next one to drop?

If you aren’t too hot on the idea of reducing your concentrated stock position, you’re not alone. A lot of investors feel the same way — whether because of an emotional attachment, a desire to not pay taxes right now, or a strong belief that the stock will keep going up. Or maybe you’re like the executives I mentioned above, and you’re restricted from selling whenever you want.

Yes, you’ll probably have to pay capital gains taxes if you sell down your concentrated position. But as far as problems go, that’s not such a bad one to have, since it means you’ve built wealth. The thing is, your financial goals (and your current lifestyle) might depend on that money — if the company’s stock plummets, you’re going to have less of an I-have-to-pay-taxes problem and more of a my-net-worth-just-took-a-dive problem.

OK. How do you fix it?

If you have a concentrated stock position, you should strongly consider diversifying it. There’s a reason we’ve all heard the saying, “don’t put all your eggs in one basket.” Diversification may mean shelter from the storm.

Today, as Ellevest’s Director of Investments, I work closely with our financial advisors serving Ellevest Private Wealth clients. Our job is to design and maintain investment portfolios in our clients’ best interests. And that often includes strategically diversifying concentrated positions. Here’s an example “before and after” of diversification. (Note: This example is 100% hypothetical … not a real person’s plan.)

Diversifying concentrated stock positions

There are a couple ways you can get from the first pie chart to the second.

The most straightforward way is to sell some of the stock you’re concentrated in. We might do this over the course of multiple years, and you’ll want to do this in the most tax-efficient way. You might have losses in other positions that you can sell, and then use the losses to offset gains in the concentrated position. Or you can work with your financial advisor to create a tax budget, such as, “I'm willing to realize around $100k in gains each year.” Another strategy — if you don’t need that money — could be to create a donor-advised fund, which lets you donate stock, get an immediate (same-year) tax benefit, and then make grants to charitable organizations from the fund over time.

Regardless of the approach you pick, the idea is to consciously diversify into other asset classes (fixed income, alternatives, international equities, etc.) that balance out the risks of the concentrated position. That way, you don’t have to wait for hindsight to be 20/20: Put yourself in a position where you’re more likely to thank that stock for helping you build wealth — and thank diversification for helping you keep it.


Disclosures

© 2018 Ellevest, Inc. All Rights Reserved.

You can review Ellevest’s Form ADV Part 2 here.

The information provided in the pie charts does not take into account the specific objectives, financial situation or particular needs of any specific person. The portfolio asset allocations shown are hypothetical in nature and for illustrative purposes only. This information does not represent actual securities or client performance and should not be relied upon as investment advice. It should not be assumed that the asset allocations shown will be profitable or protect against a loss in a declining market. There is no guarantee that any particular asset allocation will meet your investment objectives or provide you with a given level of income.

Information was obtained from third party sources, which we believe to be reliable but not guaranteed for accuracy or completeness. The information provided should not be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice.

The information provided does not take into account the specific objectives, financial situation or particular needs of any specific person.

Diversification does not ensure a profit or protect against a loss in a declining market. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.

Investing entails risk including the possible loss of principal and there is no assurance that the investment will provide positive performance over any period of time.

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Jennie Sanders

Jennie Sanders is the Director of Investments at Ellevest. She designs custom, strategic investment portfolios for Ellevest Private Wealth clients. She is also a CFA charterholder and spreadsheet whiz.