Baby boomer clients preparing to retire within the next 10 years may soon be faced with a problem regarding their stock holdings. That problem is concentrated stock positions, or owning too much of one company’s stock.
“Any individual holding that makes up more than 25 percent of the client’s overall investment holdings is considered a concentrated position,” says David L. Kaiser, ChFC, AIF, president of Denver-based Pinnacor Financial Group. Kaiser, who’s been in the business of advising high-net-worth individuals, executives and small business owners for close to 15 years, has met people who had 50 percent, 80 percent and even 100 percent of their investment net worth in a single stock position. “The trick is unwinding the concentrated position over time.”
“All too often, people end up with a large position in a particular stock due to an emotional attachment, especially if the stock’s performance has made them rich. Large individual positions are built and acquired every day through employer retirement plans and stock ownership plans, stock options and inheritances,” Kaiser explains.
From a tax standpoint, they may be retaining the position or delaying rebalancing their portfolio because they do not want to pay taxes on capital gains, or maybe they own restricted stock (shares that can only be sold at some time in the future). In any case, they need to be aware of the risks associated with holding a concentrated stock position. If they want a second opinion on this matter, just ask any former Enron employee.
The Risks of Concentrated Stock Ownership Owning a concentrated stock position creates a potential problem because such a large portion of the client’s wealth is dependent on the movement of one particular stock. Owning a concentrated stock position exposes them to higher volatility, lower liquidity and higher risk than the ownership of a diversified portfolio.
When to Divest a Concentrated Position Diversification can both reduce risk and foster higher long-term growth, but when is the best time to divest a concentrated position? According to Kaiser, advisors are wise to encourage selling at least some of the shares. “The optimal amount to sell rises when the client has a longer time horizon for holding the concentrated position, or when there is lower tolerance for risk, lower tax implications attached to selling the stock or higher single-stock volatility.”
Strategies for Divesting a Position Using Share Selection. This strategy involves liquidating a large portion of a concentrated stock position now and taking advantage of the low 15 percent long-term capital gains rate. If the shares are selected wisely, you will sell the ones with the highest cost basis, thus minimizing the overall capital gain.
Selling Stock in Equal Stages. You might help your clients decide to sell 75 percent of their concentrated stock over the next five years. By spreading the sales out over future years, you lower their exposure to capital gains taxes in any one given year. If in any given year the clients’ income level is lower than in previous years, it may be beneficial to sell a larger portion of their stock position at that time.