Financial Planning Retirement Retirement Red Zone Legacy Planning
When you own a highly concentrated winning stock, you probably feel like you’ve hit the jackpot. But you might be left with a riskier portfolio or a large tax bill. Discover smart strategies to de-risk your exposure and mitigate capital gains tax.
Published by Motley Fool Wealth Management Originally posted on Wed, May 17, 2023 Last updated on January 9, 2024
5 min read
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Were you lucky enough to buy Apple stock (AAPL*) on April 8, 1983, for $0.18 and, more impressively, still hold it? Or did you receive stock options from Microsoft (MSFT*) when you worked there in the early 1990s for $1 a share? While these are good problems to have—Taylor Swift would say "Champagne Problems"—they potentially leave you with a riskier portfolio or a large tax bill if you sell them. So how should you handle a significant, appreciated stock position? A concentrated position in any one security can pose two distinct problems. Problem 1: The inherent risk of having a substantial portion of your wealth tethered to one company. This risk highlights the concept of diversifiable vs. nondiversifiable risk. Investors can diversify specific risk from one company by holding more than one security. For example, research shows that holding roughly 20 stocks potentially can diversify away about 80% of the risk.1 But even if you have 20 or more stocks, a single company concentration may limit the impact of that diversification—losing the punch you hoped it could deliver. Problem 2: Diversifying a large, appreciated position often triggers a significant tax bill. Even if you recognize that you're overly concentrated in one stock, reducing exposure is complex. One of the downsides most people want to avoid is paying capital gains tax on the sale of a sizeable stock gain. While there are no easy solutions, there are options to dilute the unwanted intensity from such a large position. De-risking considerable exposure to one company typically requires complicated financial maneuvering. Several methods focus on limiting the effects of a downside move or protecting against a steep decline in the stock. For example, some investors hedge their position with equity options. A common strategy is to employ an equity collar—which is to say they buy put options and sell call options on the stock. Buying a put option provides downside protection, while selling a call option gives the investor income. Of course, an equity collar is just one risk-mitigation strategy. Additional strategies involve other derivatives, like forward contracts. In addition to protecting against downside risk, some investors attempt to capture the upside simultaneously. An example is to participate in an exchange fund where investors pool concentrated shares and each investor receives a slice of the pool. Again, these are complex ways to minimize the risk and often require meeting specific criteria, rules, and regulations, so consult with a Wealth Advisor or investment professional. There’s no simple way around selling appreciated stock while you’re alive and not paying long-term capital gains tax. So what should you do? Here are five tax-mitigating strategies that may work for you. As with any tax strategy, you should always consult a tax professional before making these or other tax decisions. Motley Fool Wealth Management can counsel on tax efficiency and general tax considerations but does not (and is not permitted to) provide tax advice. As we said earlier, a concentrated, appreciated stock position is enviable. But it also requires diligence and care to unwind properly. Fortunately, you have options. So whether you’re looking to hedge your risk, dilute your exposure, or perhaps both, we believe it’s best to work with a Wealth Advisor to understand how doing so may fit into your overall wealth plan. For example, gifting a concentrated position may make sense if you have legacy aspirations. But suppose you prefer to unwind the position and diversify your holdings. Tax loss harvesting or tactically trimming may be a better route to explore. Or, both approaches may work. Again, you have choices, and that's why we believe having a financial professional in your corner is beneficial.Problems with a concentrated stock position
Concentrated risk solutions
Diluting exposure without triggering a massive tax bill
You have choices
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Financial Planning Retirement Retirement Red Zone Legacy Planning
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Footnotes
*All information presented herein is for informational purposes only and should not be deemed as investment advice or a recommendation to purchase or sell any specific security. The securities identified and described in this article do not necessarily represent the securities purchased or sold for our portfolios. You should not assume that an investment in these securities was or will be profitable, and there is no assurance, as of the date of this presentation, that the securities have been or will be in any model portfolio. All information expressed in this article is subject to change without notice. There is no representation or guarantee that any opinion, estimate or projection will be realized. The information is believed to be reliable at the time of publication of this article in May 2023; however no representation or warranty is made concerning its accuracy. Past performance is no guarantee of future results. All investments involve risk and may lose money (including principal).
1Jstor.com, Oct 1997
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