Managing a Concentrated Stock Position

In life, people say “don’t put all your eggs in one basket.” In investing, we use a big fancy term that means the same thing: diversify.

Investors are told to spread their money across many stocks and indexes to protect against risk. This works to protect your money by limiting volatility and allowing your gains to offset your losses.

But what happens if you find your money has ended up concentrated in one position?

This can happen for any number of reasons. Maybe you inherited the position or sold a private business. Whatever the reason, finding you have a concentrated stock position carries unique challenges. We’ll get into them below.

The Challenges of a Concentrated Stock Position

You can discover a large stock holding by several routes, with each one requiring a different approach if you want to solve it. Some of these routes include:

• Inheriting a large holding.
• Exercising options to buy your company’s stock.
• Selling a private business, or founding a company that later went public.
• Benefitting from price appreciation or stock splits over the years.
• Accumulating restricted or common stock as part of your compensation.

While these are all positive situations, they create challenges. Some examples include:

• Reluctance to sell because of adverse tax consequences.
• Legal constraints on your ability to sell.
• Contractual obligations that prevent selling, such as lock-up agreements.
  • Executives of a company that has recently gone public may be subject to an agreement with the stock’s underwriter that prohibits their selling within a given period after the IPO.

• Practical considerations.
• Emotional attachments to a stock.
• Desire to participate in potential future price gains.
• Concerns about the possible perception of market manipulation or insider trading.

Some strategies can help you address these issues. One of them, or a combination, might suit your unique situation. The choices are complex and will depend on your circumstances and tax considerations, but here is an overview of some of your options.

Sell Your Shares

The most straightforward approach, selling frees up funds that can be used to purchase other securities that will help diversify a portfolio.

Even if a stock has done well in the past, there’s no guarantee it will continue to do so, and even if it does, it could represent an even larger percentage of your portfolio, thus compounding the risk. The more volatile the stock, the lower its risk-adjusted return relative to the broader market tends to be over time.

The biggest tradeoff with this option is that you’ll owe capital gains taxes on the difference between your cost basis and the sale price. If you have a highly appreciated stock, that may be no small consideration.

Keep in Mind:

• You’ll need to weigh the tax impact and trading costs against any additional potential return you might gain or potential losses on your concentrated holding that you might avert by diversifying.
• Selling doesn’t have to be an all-or-nothing proposition. If you want to continue to participate in any upside potential, you could sell only a portion of your position, or consider selling over time.
• Selling in stages can help you better manage the tax bite in any one year, yet allow you to participate in any
  future growth.
• If you’re in poor health or have reached an advanced age, remember that if the stock is part of your estate, the cost basis may be stepped up after you pass.

Restricted Shares

If you hold restricted shares or want to avoid the perception of insider trading or market manipulation, you can sell shares over time by using a 10b5-1 plan.

So-called because they are spelled out in SEC Rule 10b5-1, such plans can provide a documented defense against any allegations that your trades were made to take advantage of insider knowledge.

10b5-1 Plans:

• Must be set up through an independent third party, such as a financial advisor, broker, or trustee.
• Cannot decide when and how much to sell based on any material knowledge about the company that is
  not public.
• May spell out a predetermined schedule for selling shares over time, specifying in advance the dates, prices, and amounts of each sale.
• Could also set out a formula, algorithm, or computerized program for automating the trades.
• May set up a mechanism that eliminates the investor from any decision-making about the sale

By making clear in advance your plans to sell your stock, a 10b5-1 plan is designed to demonstrate you are complying with SEC Rule 144, which governs public resale of restricted securities and was designed to prevent insider trading, and that those trading decisions were not based on any material, nonpublic knowledge about the company’s prospects.

Make sure that when you adopt a 10b5-1 plan you intend to carry it through. The selling decisions are considered irrevocable, and attempting to change them or terminating the plan early could raise questions about the plan’s legitimacy, thus potentially bringing on precisely the problems you established the plan to avoid.

Conclusion

There are a lot of options for handling a concentrated position. Which one to choose depends on your unique situation.

As experienced financial professionals, we are here to help you overcome the obstacles that investors often face so you can seize the opportunities before you. We’re here to serve as a resource for you to discuss your current financial situation and future goals.

Please connect with us and let us help you discover your dream life by securing your future through investing. We would be delighted to go on the journey with you.