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Too Much of a Good Thing

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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.

Gifting. If they’re still concerned about the tax bill that may result from the sale, they may want to consider gifting the stock to children/grandchildren or a favorite charity. An individual can gift $12,000 per year to anyone he likes and still avoid a gift tax. If it is a charitable gift, there should be a tax deduction.

Hedging the Client’s Position. For some investors, hedging strategies can protect wealth, delay taxes and diversify a portfolio all at once. Here, compliments of David Kaiser, are some strategies to consider:

Charitable Remainder Trusts (CRT). Highly appreciated stock is transferred into a charitable trust, and the investor receives both a charitable deduction and an annual income stream from the trust.

Equity Collars/Options Strategy. Collars are created by the simultaneous purchase of a put option and sale of a call option. Using this strategy provides the investor with a guarantee that his or her concentrated position will have a value within the minimum and maximum price for the period the options cover. Buying puts and selling calls can also help reduce the market risk of owning a single stock position. However, keep in mind that transactions that effectively offset a stock position may cause the realization of a capital gain by way of the constructive sale rule (Section 1259 of the Internal Revenue Code). This rule was introduced to stop investors from avoiding capital gains tax by simply offsetting speculative and hedge positions.

Covered Call Options Strategy. The covered call is a strategy in which an investor writes a call option contract while at the same time owning an equivalent number of shares of the underlying stock. If this stock is already held from a previous purchase, it is commonly referred to as an “overwrite.” In either case, the stock is generally held in the same brokerage account from which the investor writes the call, and fully collateralizes, or “covers,” the obligation conveyed by writing a call option contract. This strategy is the most basic and most widely used strategy, combining the flexibility of listed options with stock ownership. While this strategy can offer limited protection from a decline in price of the underlying stock and limited profit participation with an increase in stock price, it generates income because the investor keeps the premium received from writing the call. At the same time, the investor retains all benefits of underlying stock ownership, such as dividends and voting rights, unless he is assigned an exercise notice on the written call and is obligated to sell his shares. The covered call is widely regarded as a conservative strategy because it decreases the risk of stock ownership.

Conclusion Although many investors have profited quite handsomely from retaining and accumulating large quantities of one particular stock, it is important for them to recognize the risk and the exposure to volatility associated with this strategy. In the last five years, many investors have lost a significant portion of their investment assets because of overexposure to a single company’s stock or a lack of portfolio diversification. Numerous lawsuits have plagued the financial industry and many workers still dream of eventually winning compensation for their losses, but the reality is that for most of these people, their dreams of early retirement have been shattered. Don’t let this happen to your clients — help them diversify and invest wisely.

Marie Swift is the president of Impact Communications, a marketing and communications firm for independent advisors; see


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