Strategies to Reduce High Stock Concentration and Lower Taxes, Recommendations from a Financial Advisor
Investing in a single company can offer significant returns, but it also comes with the risk of overexposure. This can subject an investor to greater risk than they are willing to tolerate, as a dip in market value due to company-specific issues or a regulatory shift can hit a portfolio hard. Moreover, selling even part of a holding could trigger a significant tax bill, pushing one into a higher bracket and impacting Social Security, Medicare premiums, or eligibility for certain deductions.
High-net-worth individuals, including first-generation wealth builders and corporate executives, often face the risk of having a single stock threatening their wealth. This risk can come from compensation, inheritance, or company loyalty. To combat this, wealth advisors like UBS, Merrill Lynch, and Morgan Stanley often recommend using Exchange funds, Charitable Remainder Trusts (CRTs), Direct Indexing, and Donor-advised funds (DAFs) to reduce concentrated stock positions while minimising tax liabilities.
One such strategy is Direct Indexing. This approach keeps the concentrated stock and surrounds it with other holdings, creating a more balanced, tax-aware portfolio. With direct indexing, you can harvest capital losses from underperforming stocks to offset gains as you gradually reduce your exposure. This method allows for mimicking the performance of a broad index, such as the S&P 500, by purchasing the individual securities within it.
Another strategy is the use of Donor-advised funds (DAFs). These funds can be a smart tool for contributing appreciated stock, receiving a deduction based on the fair market value, and avoiding capital gains tax on the donated shares. DAFs also free up future cash flow, which can then be used to further diversify your portfolio. Additionally, DAFs allow you to recommend grants to your favourite nonprofits over time. They are particularly useful if you want to front-load several years of charitable giving while reducing your exposure to a concentrated stock position.
Charitable Remainder Trusts (CRTs) are another underutilized strategy. CRTs provide income to the donor for a specified period, after which the remaining assets are donated to a charitable organisation. This can help reduce exposure to a single stock while managing tax liabilities.
Exchange funds, while not specifically named in the bullet points, are another strategy often recommended by wealth advisors. These funds allow you to exchange a concentrated position for a diversified portfolio of stocks, thereby reducing risk and potential tax liabilities.
A case in point is a retired pharmaceutical executive who held a large amount of company stock. By diversifying their portfolio using direct indexing and a donor-advised fund, they were able to create a diversified, tax-efficient portfolio aligned with their long-term goals.
In conclusion, if any one stock makes up more than 20% of your portfolio, it's time to take a closer look and work with a qualified adviser. The biggest hurdle to diversifying a concentrated position is the capital gains tax, but strategies like those mentioned above can help mitigate this risk and protect your financial future.
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