Primary Solutions for Managing Concentrated Stock Positions

In today’s world, it’s not unusual for an individual’s or family's wealth to be the result of one or two concentrated stocks having done particularly well throughout a lifetime. Executives and lifelong employees typically amass these sizeable positions via employee compensation (restricted stock, stock options, etc.), employee stock purchase plans, and IPOs. Additionally, family members of these individuals may have been gifted stock over the years, or may have inherited stock upon the death of parents, grandparents or other relatives. Despite these positions providing individuals and families with the aforementioned prosperity, concentrated positions also carry with them tremendous risks, some of which can deflate a portfolio in little or no time (think Enron or Lehman Brothers).

While the risk is almost always recognized, it isn’t always addressed for a variety of reasons – most of which have to do with an emotional attachment and/or the desire to avoid paying any taxes. For example, individuals have seen the stock do incredibly well throughout the years and have no reason to believe the stock’s value will stop appreciating in value. Furthermore, due to the significant appreciation of the stock, these individuals don’t have any interest in recognizing gains and paying capital gains taxes (to the IRS and/or their state) that have been generated. With that being said, the "costs" associated with doing nothing can be significant, and have been for individuals and families with significant exposure to many stocks throughout the last decade. For example, a $1 million position in Exxon Mobil purchased on January 2, 2009 would be worth a little less than $1.3 million as of July 31, 2019, whereas a $1 million position in a basket of large-cap stocks (an ETF designed to replicate the S&P 500) would be worth approximately $3.8 million as of July 31, 2019.

As with any financial planning considerations, individuals and families with exposure to concentrated positions need to think long and hard about their financial objectives, tax situations, cash flow needs, etc. before identifying any solutions. An overview of some of the more common solutions that individuals and families can utilize to help manage their concentrated positions, and consequently lower their overall portfolio risk, are as follows:

1.    Selling the Position

One of the simplest and most efficient ways to reduce the risk associated with concentrated stock positions is to simply sell the shares. However, the manner in which an individual sells their shares can have varying implications. The most radical solution involves selling the entire position at one time. Obviously, this course of action immediately eliminates the concentrated risk; however, it presents the potential for a large tax liability in most scenarios.

Instead of utilizing this drastic approach, individuals can sell out of their position over time by selling specific tax lots. Tax lots represent the "cost" of shares of stock purchased at a particular price on a particular day. For example, one tax lot may consist of 100 shares purchased at $100/share ($10,000 total cost) on Jan. 1, 2019, while another lot may consist of 100 shares purchased at $105/share ($10,500 total cost) on Feb. 1, 2019. By utilizing the approach of selling specific lots, individuals can realize gains that will result in the tax liability they’re willing to incur. However, one downside associated with this approach is that individuals are put into a position in which they will maintain a higher level of exposure over time as they gradually liquidate different tax lots.

2.    Utilizing Stock Options

Another option that individuals can utilize to help reduce the risk associated with concentrated stock positions involves purchasing stock options. Stock options are derivatives that provide individuals the right to buy (call) or sell (put) a stock at a specific price within a specific time frame.

A relatively elementary option strategy associated with concentrated stock positions entails buying put options. Again, put options provide an individual with the right to sell a stock at a specific price. By purchasing a put option, individuals are able to "lock-in" a price at which they’d be able to sell their concentrated stock position (particularly in the event its stock price goes down). This strategy allows for individuals to participate in the stock’s upside (if its stock price goes up), while limiting their exposure to the downside. The main drawback from utilizing this strategy is that it can be costly; options expire, and if an individual is interested in maintaining this "hedge," they’ll have to buy additional protection (puts) when older puts expire.  Lastly, there are other strategies involving stock options (most of which are more complicated) that may be more effective depending on an individual’s circumstances and risk level.

3.    Charitable Contributions

Typically, when individuals donate to charitable organizations, their primary motivation is to contribute to a cause that is significant to them or their family.  And the tax deduction is "gravy," so to speak. The deductibility of these contributions is based upon a number of different factors, but in most cases, taxpayers are able to deduct the amount of the gift on their tax returns. In addition, these contributions may very well provide for an ancillary benefit if the contribution is made with a concentrated stock position, as it will reduce the individual’s stock exposure. When donating to charities, individuals can elect to donate shares that have resulted in substantial unrealized capital gains since the date of acquisition (as long as the holding period is at least one year). Instead of recognizing this capital gains tax as a result of selling and subsequently donating cash, individuals can eliminate the capital gains tax they would have otherwise owed on these shares by donating the shares directly to the charity. It is worth mentioning, donating securities that have the largest unrealized gains is generally the most tax-efficient manner in which to donate.

Simply put, individuals and families with concentrated stock positions have a lot to consider. The different consequences that can arise from these many considerations can be difficult for individuals to navigate. We encourage you to engage with a trusted advisor to have a conversation about how some of the concerns you may have and how they can be addressed.

Nicholas R. Groman, CFP^®, MBA is a Senior Associate, Financial Planning Specialist with MAI Capital Management, LLC.  A native of Cincinnati, Nick is a graduate of Mount Saint Joseph University. Nick holds an MBA from Xavier University, is a Certified Financial Planner™ and is currently enrolled at Northern Kentucky University’s Salmon P. Chase College of Law.  Prior to joining the firm, Nick worked at Fidelity Investments and John D. Dovich & Associates, LLC.

Disclosures:

MAI Capital Management, LLC (MAI) is a privately held independent investment advisor registered with the Securities and Exchange Commission and headquartered in Cleveland, Ohio, with regional offices in Columbus and Cincinnati, Ohio as well as offices in California, Florida, New Hampshire, and Virginia.  MAI’s Cincinnati office is located at 625 Eden Park Drive, Suite 310, Cincinnati, OH 45202. For more information, call 513.579.9400 or visit www.mai.capital.  Any reference to or use of the terms "registered investment adviser" or "registered," does not imply that MAI or any person associated with MAI has achieved a certain level of skill or training.  Any statistics mentioned have been obtained from sources we believed to be reliable, but the accuracy and completeness of the information cannot be guaranteed. Any statement non-factual in nature constitutes only current opinion of this author which is subject to change without notice. Option trading may entail significant risk and is not appropriate for all investors. Neither the information nor any views expressed should be considered as investment advice or constitute as a recommendation to buy or sell any security, strategy or product nor should it be considered as a forecast of future events or a guarantee of future results.