Concentrated Stock Position: Do You Have the CHOPS to Diversify Your Portfolio?

Concentrated Stock Position: Do You Have the CHOPS to Diversify Your Portfolio?

Some say that wealth is built with concentration and preserved by diversification.

So you’ve found yourself with a concentrated stock position. A large portion of your portfolio — or maybe the whole thing — is at the whim of how a single stock performs. Perhaps you also work for the company that issued that stock. You’ve got a great career with a solid employer, but depending on it for the vast majority of your income and assets just feels too risky. What should you do about all of that stock?

Let’s start with what a concentrated stock position is. How much is too much of one stock? If a single stock position makes up even 10% of your portfolio, it’s considered concentrated. If you’ve got a strong appetite for risk, this might be completely acceptable. But when you get closer to the 20% mark, nearly a fifth of your assets are reliant on the performance of just one company. Even a deep-set core belief that the company will do well might be more of a risk than you’d prefer to take.

How to Diversify Your Stock Portfolio

To reduce that risk, you might swap some of those for an array of diverse stocks in your portfolio. That’s one way to thin out that single stock position and diversify your holdings to match your risk tolerance. But there are more options to diversify than just selling a bunch of identical stock and buying a mix of different ones.

That’s where your diversification CHOPS come in! I’ll break down the ways to diversify through each letter of this acronym. My hope is that you’ll better understand your options for exiting your concentrated stock position — and know what you can do to avoid letting it build to an uncomfortably risky level again.

C: Cash-out

Cashing out, or selling, some or all of your stock with the concentration is, at face value, the simplest way to diversify. But it’s necessary to keep in mind that, depending on the type of account in which you hold that stock, selling can come with tax consequences.

Lucky for you, there are some ways to cash out in tax-savvy manners. For example, you might consider a strategy that includes selling out of your concentrated position over years rather than all at once to spread out the taxes and take advantage of tax brackets rather than fall victim to them. You could also utilize tax-loss harvesting inside a direct-index strategy to trim gains while maintaining a much more broadly diversified investment mix. Also, look to diversify your holdings in tax-advantaged vehicles and continue to hold a concentrated position in your taxable accounts.

Whatever path you choose, if cashing out is for you, be sure to do some tax planning alongside your investment planning.

H: Hold

Ok, you got me. Holding onto a concentrated stock position is the opposite of diversifying it. But you don’t have to diversify your concentrated position to end up with a properly allocated portfolio. Instead, you can continue to hold that concentrated position and diversify your other holdings.

Holding many shares of that single stock might make sense if you’re subject to restrictions where you can’t sell the stock. You could very strongly believe that it will perform well. Or you might be looking at capital gains taxes or the income the sale would generate and don’t find it suitable to your tax situation.

Unless you have a really good reason to not do this, rule number one is: Stop buying more! Sell RSUs and ESPP shares immediately as they vest. Diversify your other holdings by adding dollars and buying into new stock positions, not your concentrated one. This reduces the weight of one position by growing other areas of your portfolio. While it’s not always possible for a number of reasons, including the fact that money doesn’t grow on trees, it’s still a viable way to diversify around a concentrated position rather than out of it.

O: Options

You might’ve heard some horror stories about people getting in over their heads due to trading options during the pandemic. But don’t be afraid! When done properly, options trading can help diversify a concentrated stock position and offer additional benefits.

From buying puts to selling covered calls and combining them into an equity collar, you’ve got options (see what I did there?). To put it simply, buying puts means paying for the option to sell stock at a specific price throughout a specific time frame. Selling calls means that you receive a payment for an option that gives the call buyer the right to buy your stock from you at a specific price throughout a specific time frame. The equity collar combines both, allowing you to manage both your upside and downside risk.

P: Philanthropy

Charitably inclined? You could diversify your portfolio by making your regular charitable donations in the form of your concentrated stocks rather than cash. In addition to fulfilling your gifting goals, philanthropically diversifying your portfolio also gives you the benefit of avoiding the capital gains you’d incur if you sold the stocks and gifted the cash. Plus, your gift is eligible for an income tax deduction, making it a (charitable gift) win – (diversification) win – (tax deduction) win!

If you choose this route, you’ve also got some serious potential for nabbing a solid income plan, a tax deduction, and satisfaction in knowing you’ve supported great causes! You could use a gifting vehicle to make your charitable contributions to maximize both the dollars given, the income you receive in return, and the tax deduction you take. From charitable remainder trusts to donor-advised funds and outright gifts, be sure to speak with your financial and tax advisor about this one.

S: Swap

I get it. This one sounds like selling your stock and buying something different. But that’s not the case with this stock swap! (Try saying “stock swap” 10 times fast — or watch this classic Elaine Benes line!)

What I’m talking about here is an exchange fund. Here’s how it works: Multiple investors with concentrated stock positions in different companies get together and pool their shares. The mix of blended positions in the pool inherently diversifies it, and each investor receives their “swapped” share of contributions back in units of the pool of stocks. The exchange fund is taxed as a partnership and you have to meet certain financial qualifications to participate.

In addition to diversification, the unit holders haven’t sold their positions, so they don’t owe capital gains until they sell their units. If the managers of the pool sell a particular stock, the basis in the stock that the original owner brought to the pool is then spread out among all unit owners. This reduces capital gains to which an individual owner of a concentrated position would be subject by spreading it out among all unit owners. Sharing is caring!

How to Maintain a Diversified Stock Portfolio

Now that you’ve got your portfolio where you want it, how can you keep it properly allocated so it doesn’t get too concentrated again? Check in!

You probably know that, here at FPFoCo, we reallocate and diversify accounts for clients like you. Other indicators that you might want to review your portfolio include regular equity compensation vesting events and stock splits. Less common situations, like receiving an inheritance or gift in the form of stock, also mean that it’s probably time to review your portfolio.

If you have questions about your allocation or would like a review of your concentrated stock position, head to our meeting page. As a comprehensive services client, you’re always welcome to schedule some time to meet with us, included in your ongoing implementation support.