Concentrated Stock – A Risk That Needs to Be Managed
-Written by Martin X. Shields, CFP®
When an investor holds a large position in one stock position there is the potential of accumulating great wealth. There is also the potential of losing great wealth with concentrated stock positions. This risk reward equation makes it paramount for investors to have a plan on how to manage any wealth that has been accumulated with concentrated stock position. There are a number of strategies to consider each with its pros and cons.
One option is establishing a plan to sell equal amounts of the stock over several years. This will allow the investor the opportunity to spread their capital gains over multiple years. Under this strategy an individual can take advantage of additional appreciation in the stock price while putting a stop loss order at specific price below the current market price of the stock to protect against declines in the stock price. This strategy will provide a floor on how low the stock price can go and lock in gains if the price begins to decline while capturing gains if the stock price increases.
If an individual has charitable inclinations, they can donate part of the highly appreciated stock to a charity. This will allow them to deduct the value of the appreciated shares and avoid paying taxes on the gain. The other option for individuals with charitable inclinations is to take the highly appreciated stock and transfer it into a Charitable Remainder Trust (CRT) or Charitable Lead Trust (CLT). These strategies will allow the investor to support a charitable organization, avoid capital gain taxes and either receive an annual income stream from the trust or determine a beneficiary to receive the assets in the trust after their death.
There are several other options that can be used to lock in gains and limit capital gains tax for concentrated stock position. They include hedging the positions using options or establishing limited partnerships where the stock can be placed to limit capital gains taxes. These strategies are more complex and are best used for extremely large concentrated stock positions.
Regardless of which strategy is utilized, it is always important to have a strategy to sell equity positions as gains are built into the positions. Having a disciplined sell strategy helps provide peace of mind to the investor and reduces the risk of gains being eliminated by dramatic declines in the price of the stock.