This article was updated in December 2023 to reflect current tax laws and limits.

There’s an old investment saying, “Concentrated wealth makes people wealthy, but diversified wealth keeps them wealthy.” One of the most common concentrations of wealth people have are large or concentrated stock holdings in a single company. Publicly traded companies often compensate employees with stock or stock options, especially upper-level executives. Others may have large holdings from investing early in an initial public offering (IPO) or inheriting a large holding. No matter how it was obtained, owning a large stock position creates investment and planning challenges.

DEFINING A CONCENTRATED STOCK Position

The definition of a concentrated stock position varies. Some define it as any position greater than 10% or 20% of a portfolio. A more individual metric is to define it as the size of an individual position that can negatively affect an investor's financial plan. That can be a position that is 5% of a portfolio or 50%, depending on the investor’s goals.

Why is Concentrated Stock a Risk?

The worst-case scenario of having a large amount of wealth in one stock is that the company goes bankrupt and the stock value drops to zero. That would destroy or severely impair the financial future for many. A less obvious and more common risk is that the company under performs for a prolonged period. This can be due to the company’s sector falling out of favor, heavy regulation, or mismanagement of the company. In this case, the stock holding becomes a liability as opposed to the value generating asset it was in the past.

There is usually more volatility in owning a single stock. The volatility risk is especially acute if cash is needed and the stock must be sold to raise funds. Volatility increases the chance that the stock sells at a lower value.

Emotional Attachment To A Company Can Be Strong

There is often a strong emotional attachment to large stock holdings. It can be difficult to sell shares of a company that you put so much of your effort, energy, and life into. For those who inherited the position, the loyalty can be strong for the company that has been the source of the family wealth. Also, the stock usually has become a large portfolio position because it’s been profitable. It is difficult to let go of a high performing stock that has outperformed the overall market.

But relying on one company to achieve your financial goals generally risks the overall portfolio valuation, increases volatility, reduces liquidity, and leaves the portfolio vulnerable to sector slowdowns or adverse regulations. Large setbacks by the company could jeopardize long-term financial plans. If you still work for the company of the concentrated position, your job could be at risk at the same time the stock loses value. Having your income and wealth in one company puts a lot of eggs in one basket. As such, investors generally should reduce their holding in a concentrated stock position to lessen these risks.

Even if you want to diversify from a large stock position, there are often challenges to do so. But there are a number of strategies that can lessen exposure to a single stock, diversify a portfolio, and possibly fulfill other financial goals.

SEVEN STRATEGIES FOR DEALING WITH CONCENTRATED STOCK

1. Using Options For Value Protection & Reducing the Position
2. Gifting Stock to Charity
3. Gifting Stock to Family
4. Structured Stock Selling
5. Using a Trust When Selling Stock
6. Exchange Funds
7. Stock Protection Plans

1. Using Options for Value Protection & Reducing the Position 

Stock options allow investors the opportunity to control or mitigate their downside risk. A stock option is an agreement between investors that grants each party the opportunity to buy or sell a stock at an agreed-upon price and date. There are two kinds of options:

• Call Options – allows the option buyer the right to buy the stock at the specified price.
• Put Options – allows the option buyer the right to sell the stock at the specified price.

In their simplest form, owners of call options make money when the stock price rises, while put option owners make money when the stock price falls. Buyers of these options pay a “fee” – called the premium – for these opportunities. The sellers of these options collect the premium from the buyer but are obligated to provide the underlying stock at the agreed-upon price.

How stock options mitigate risk:

Put options are often referred to as investment insurance as investors primarily purchase them to ensure losses in their stock do not exceed a certain amount. For example, say you own a stock trading at $50. You are worried about it going down in value but don’t necessarily want to sell it now and miss out on potential appreciation. If the stock price starts to slip, you may be comfortable selling all or a portion of it at $45 but not any lower. You could purchase a put option with an agreed upon price of $45. This gives you the ability to sell the shares at $45 to the other party, regardless of the actual stock price. It doesn’t matter if the stock goes to $0; the owner of the contract will still receive $45 per share from whoever sold the contract. With a put, you are essentially buying an insurance policy for the stock. Paying premiums of each option contract makes put options strategies expensive for long-term protection but more attractive for shorter periods of time.

Call options: To help pay for the premium required to purchase put options, investors will often sell call options simultaneously to collect premium from a buyer of the call option. This strategy is called a “collar” and can reduce or even eliminate the cost of purchasing put options. Let’s continue with our example from above ($50 stock, purchased $45 put option) and add that you had to pay $2 premium for the put option. You look at call options available and see that you can sell a call option at $55 for the same $2 premium. You have now created a “zero-cost collar” and are protected to the downside without paying anything out of pocket.

There are now three scenarios that can happen:

1. Stock price goes below $45.

You are able to sell your shares at $45 rather than the lower price that the stock is currently trading at. You have limited your loss to $5 per share.

2. Stock price is between $45 & $55.

You would likely hold on to the stock since it hasn’t gone to a value you aren’t comfortable with. You keep your shares and can continue to purchase additional future protection.

3. Stock price goes above $55.

Your stock will likely be “called away” and sold to the option holder for $55 per share. You may be happy with this as you have made money in the transaction.

Option strategies with low-cost basis stock:

Let’s take the example above one step further and you utilize a zero-cost collar, and the stock rises above $55. If you own a stock with low-cost basis, you probably don’t want to sell it and pay the capital gains tax. Instead, you can buy back the call option which probably would cost more than what you sold it for, creating a loss. You can then sell some of the low-basis stock by using the losses to help reduce your position. Conversely, if by using option strategies you create any gains, you can use the gains to pay the taxes for selling some of the low-basis stock. By utilizing options, you can protect yourself against a fall in the stock price and use gains or losses to whittle down your stock position simultaneously.

Get professional help:

Stock options can be complex and potentially open investors up to unintended amounts of risk if done incorrectly. It is recommended that investors work with their financial professionals to properly institute stock options in their investment strategy.

Lastly, if an executive is still employed at the company where they earned the stock, more than likely, the employee will be prohibited from buying options and will have to rely on other strategies.

2. Gifting Stock to Charity

Direct Gift of Stock

Gifting is a great strategy for reducing stock holdings with capital gains. A popular choice is gifting stock directly to non-profit charities. By donating stock instead of cash, you reduce your stock position and are likely to receive a tax deduction. Donors are eligible for an income tax deduction for the full market value of the stock, up to a percentage of adjusted gross income, depending on the recipient. You benefit by reducing your position and capital gain exposure, and the charity benefits by selling the stock while paying no tax because it is a non-profit. Everyone wins!

4. Structured Stock Selling

One option is to sell the stock or a portion of the stock outright. But long-term capital gains taxes can be as high as 23.8% for federal taxes and any state taxes will be in addition to that. Long-term gains are when an investment is held for at least one year. Any investment sold for a gain and held less than one year is considered income for tax purposes and is taxed at higher ordinary income tax rates.

One way to mitigate the tax bite is to schedule to sell a set amount of stock over time such as on a quarterly basis. The time frame can vary, but the goal is to make significant progress reducing the position. After all, reducing exposure is the goal. A 3-5-year time frame usually works well for many.

But opportunities may arise to sell more. For example, if there is a year when income is less due to reduced bonuses or being between jobs, it could be an opportunity to sell stock and take less of a tax hit. No one wants to earn less than usual, but if it happens, make lemonade out of lemons. Proceeds from the stock sale can also supplement the shortfall in income if needed.

For executives still employed by the company, scheduled selling of stock may need to take place within the approved selling open window and may be subject to required approvals.

5.Using A Trust When Selling Stock

For those who live in high tax states, using a trust has the potential to reduce state taxes. In law, the situs is the location of the trust property and its location for legal purposes¹. Funding a trust with low basis stock and using a situs in a low tax state, such as New Hampshire, can reduce capital gains taxes when selling securities. This is because the gains are subject to the law, and tax laws, of the situs state. This is true whether the trust was created with the state as situs or an old trust that changes situs to a different state.

Many high tax states have long-term capital gain tax rates of 5% or higher. If owners are selling significant positions of low-cost basis stock, the tax hit can be large. Using trusts with situs in favorable tax states can lower or eliminate the state tax bite. Federal taxes are generally not affected by the trust situs, but savings on state taxes can still be significant.

Using a trust for selling stock usually works best for larger positions of a few million dollars or more. This is because the savings need to offset legal and administrative fees. But for positions large enough, the reduction in taxes can far outweigh the additional costs.

Trust laws can be complex, and the investor could lose full access to the stock depending on the trust language and state laws. If considering using a trust for selling shares, it is imperative to work with experts. Find an attorney and trust company knowledgeable about trust situs, regulations, and state tax and estate tax laws. Some resources: IQ-EQ² Forbes³

6. Exchange Funds

Exchange Funds, or “Swap Funds,” are private placement limited partnerships or LLCs. These vehicles allow an investor to “exchange” an individual stock for shares in a pooled fund of many stocks. The funds are managed, so the stocks are from different sectors and industries to provide immediate diversification. If your original stock should drop in value, you hold the value of the diversified fund. Using an Exchange Fund also allows the original amount of the stock to be invested without first selling, paying taxes, then investing the remainder.

There are key constraints to using Exchange Funds. Individuals must be a Qualified Purchaser which is defined as having $5M in investable assets. And there are lock-up periods of seven years, potential loss of dividends, fund management fees, and other considerations. Also, if the original stock exchanged should outperform the fund, the investor is stuck with the fund value – you can’t have your cake and eat it too. Lastly, the investor  keeps the original cost basis of the stock with the new fund position, though the need to sell is less due to diversification. Still, for investors who qualify, Exchange Funds are a viable option for diversifying a large stock position.  Here is an article on Exchange Funds if you would like to learn more.

7. Stock Protection Plans

Very new to the scene are Stock Protection Plans (SPPs). These act more like insurance than diversifiers. In a typical SPP, investors holding stock from diversified industries pool together cash representing 10% of their stock values for the securities they want to protect. The investors pay a 2% upfront fee and 2% annual fee for a five-year holding period. Most of the cash is invested in 5-year Treasury Notes. After five years, if a stock has gone down in value the stock holder is compensated by the fund. The challenge is if recession hits and most of the stocks go down in value. If that happens, there generally won’t be enough assets in the fund to compensate everyone, and it doesn’t fully protect the owners.

These funds are very new and need to be fully vetted. But it may work for an investor with a matching time frame for protecting a stock value. And since the stock is not exchanged or pledged, the owner retains the stock, dividends, and voting rights.

One of the obstacles of an SPP are the fees. Paying 12% for five years of protection is expensive given that it may not work in a market downturn. Another drawback is if the stock goes up in value after five years you could end up having a bigger diversification issue than when you started with larger embedded gains. With Stock Purchase Plans, kick the tires thoroughly and make sure your situation is one that would benefit from participating.