How much is too much? How do I avoid a potentially large tax bill and still diversify? When is the right time to make a change? Where am I going to invest the proceeds?
Many corporate executives and long-tenured employees face these questions every day. Holding a concentrated stock position may result from a variety of situations, such as executive compensation, the founding of a company, the sale of a business or even an inheritance.
But, irrespective of the source, the decision to diversify can be an emotional one. Significant wealth can be built through a concentrated stock position and, conversely, can be eroded just as fast (remember Enron?). If the stock held is with your current employer, the decision to diversify is even more important because your income is tied to the same company.
While it’s tempting to get caught up in the performance of your company’s stock, the benefits of reducing concentrated risk are relatively straightforward: reduced, forward-looking portfolio risk and increased portfolio efficiency.1
Options can help hedge your downside risk while you still get to participate in some of the stock price appreciation and dividend income.
Experiencing a 20 percent loss in an individual stock requires a subsequent 25 percent gain in the following year to break even. Yet numerous strategies may be employed to reduce risk and diversify in a tax-efficient manner. The use of options can help hedge your downside risk in a company while you still get to participate in some of the stock price appreciation and dividend income. Both a “ceiling” and “floor” are established on future price movements, which allows for greater certainty and planning.
For families that are charitably inclined, a charitable remainder trust (CRT) might be a viable solution. A CRT allows an investor to transfer highly appreciated assets to an irrevocable trust in exchange for a cash-flow stream, without generating an immediate capital gains tax or net investment income surtax on the entire embedded gain.2
Tax considerations, future investment gains/losses, costs, risks, limitations and liquidity are just some of the considerations that should be weighed with any strategy.
Executives may have restrictions relative to their shares and should be aware of whether it’s necessary to execute a specific trading policy. Furthermore, due to reporting requirements, officers and directors of public companies (plus individuals with greater than 10 percent ownership of the company) must report their transactions, which may have a material impact on the public’s perception or stock performance. Liquidity concerns should be addressed for both companies with low trading volumes and, more important, nontraded, closely held private companies.
Predicting the exact optimal time to diversify a concentrated position is difficult. Choose a level that you’re comfortable with, and make gradual changes over time. This will help you avoid exposing yourself to an adverse earnings report or change in market conditions that dramatically alters your financial situation.
1UBS, Strategic Insights, Portfolio Advisory Group, March 2012, p. 1.
2UBS, Trust & Estate Insights, Advanced Planning, July 2013, p. 6.
Stuart C. McLeod and Camille Valentine are Financial Advisors with UBS Financial Services Inc. in One Post Office Square, Boston, Mass. UBS Financial Services Inc. Financial Advisor(s) engage Worth to feature this article. As a firm providing wealth management services to clients, we offer both investment advisory and brokerage services. These services are separate and distinct, differ in material ways and are governed by different laws and separate contracts. For more information on the distinctions between our brokerage and investment advisory services, please speak with your Financial Advisor or visit our website at ubs.com/workingwithus. The strategies and/or investments referenced may not be suitable for all investors. UBS Financial Services Inc., its affiliates and its employees are not in the business of providing tax or legal advice. Clients should seek advice based on their particular circumstances from an independent tax or legal advisor. The views expressed herein are those of the author and may not necessarily reflect the views of UBS Financial Services Inc. Member, FINRA/SIPC.
This article was originally published in the February/March 2016 issue of Worth.
