We’ve all heard the expression “don’t put all your eggs in one basket,” but there are some investors who don’t think that phrase applies to them. Ever known someone who acted on a “hot stock tip” only to find out it wasn’t so hot (aka gambling)? Well, there are otherwise very smart people who manage to let their exposure to a single stock grow out of proportion to the rest of their portfolio over time, and that can be a recipe for investment disaster.
Concentrated holdings in a single stock often occur when an investor accumulates stock in the publicly held company for which he/she works. These holdings accumulate from stock options, restricted stock units or participation in an employee stock purchase plan, or by purchasing company stock inside a 401(k) or deferred compensation plan. While accumulating, the investor may develop “overconfidence bias:” the feeling he/she has some knowledge advantage because they work for the company. Very often, this is not the case. Very few financial planners recommend that a single stock comprise more than 5 – 10% of a client’s overall portfolio. All one has to do is remember stocks like Enron, WorldCom or AIG to know that over-concentration can lead to financial ruin.
Another reason single stock concentration occurs is through inheritance. If a beloved family member dies and bequests a single stock they’ve held for decades, it’s often hard for the beneficiary to emotionally let go of the stock because they feel they are “betraying” their benefactor. Guilt is hardly a good investment strategy, but it does sometimes drive poor investor behavior.
A final common reason investors don’t let go of a stock they’ve been “hoarding” for decades is taxes. If that favorite stock has appreciated to a great degree over time, selling some or all of the position will trigger unwanted capital gains taxes, which can be as high as 20% if you are in the top tax bracket. Such a spike in taxable income can trigger other problems, such as higher Medicare rates in subsequent years.
So while it’s fairly easy to justify how a concentrated stock position came to be, there is little financial planning logic that supports keeping it that way – especially if that stock is part of a portfolio to be used in an overall retirement income plan. Concentrated stock positions subject a good retirement plan to unnecessary risk, which, if realized, could force an individual to work longer, have to go back to work, live on less income in retirement, or other unpleasant trade-offs.
There are several strategies available to manage the risk and the potential taxes from reducing a large single stock position in a portfolio. Simple strategies include spreading sales of stock out over several years, or selling other stocks carrying a loss position so as not to experience the “tax bite” all at once. Another frequently-used strategy involves using appreciated stock to meet charitable giving goals, by donating some stock to a charity or donor-advised fund. Other, more complex strategies exist as well, which can be part of a more sophisticated tax, income and legacy plan.
So if your favorite stock is more than 10% of your total portfolio, it may be time to start working with a good financial planner to come up with a strategy that’s right for you to reduce this concentration risk over time.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor
Content in this material is for educational information only and not intended to provide specific advice or recommendations for any individual.
Karin Grablin, Certified Financial Planner®, CPA, MBA, is with SRQ Wealth, 1819 Main Street, Suite 905 in Sarasota (941-556-9004; [email protected]). Securities offered through LPL Financial. Member FINRA/SIPC. Investment advice offered through SRQ Wealth Advisory, a registered investment advisor. SRQ Wealth and SRQ Wealth Advisory are separate entities from LPL Financial.