In wealth management, you often hear the phrase: “concentration builds wealth, diversification preserves it”. What this means is that numerous individuals and families have accumulated great wealth by holding large amounts of a single highly appreciated stock. The investor may have acquired the stock in a sale of a business or an acquisition, superior investment performance or stock options such as in some of today’s high flying tech & biotech companies or simply through an inheritance.
Holding onto a single stock is alluring; many great fortunes have been minted this way. From Bill Gates, Jeff Bezos or Mark Zuckerberg, to Elon Musk, the list goes on. Often times, you’ll see that at some point, even these astute and successful entrepreneurs and despite their continued belief in their respective companies will start diversifying their holdings and spreading their concentration risk.
It’s just not prudent to tie up much of your wealth into one stock regardless of how great the company or stock may be. We certainly have many examples of companies that were once great and ended up losing most of their value due to either market trends, changes in the economic or market cycle or mismanagement and accounting irregularities (remember Enron). You simply don’t know what the future holds.
Furthermore, tying up all of your wealth in a concentrated position creates a huge dilemma for clients, advisors and tax professionals. The stock may continue its upward movement which should certainly be a consideration, but selling it will entail a substantial cost, a daunting tax bill.
It is important to understand the risk of single stock concentration and the importance of diversification, here are some consideration when dealing with diversifying your positions:
1. Keep track of all your positions (options and RSUs) and pay close attention to how much it contributes to your net worth. The more it contributes the more pressing is the need to diversify.
2. Set appropriate financial goals for proceeds from the sale of your options. If your goals are short term, such as pay taxes or buy a home, you should diversify and invest in the proper allocation.
3. If uncertain about the tax ramifications of exercising or selling your options or RSUs, work with a GK advisor and your CPA to figure out the best course of action. The cost of inaction may just be too high, just look for help.
4. While minimizing taxes should be an important consideration when figuring out a strategy, it is important to consider that there’s no guarantee that the stock will keep rising, so don’t be greedy.
5. Don't second-guess yourself when selling stock. If the price goes up after you have sold it, you still have made a profit since you still have a position in the stock, and as the adage goes, you can never go wrong taking profits.
6. Plan for taxes before you sell company stock. Then when you do sell, set aside money to pay the IRS, or consider estimated taxes, particularly if the withholding at exercise with options or vesting with RSUs did not cover the amount you will owe with your tax return.
7. Don’t feel disloyal about selling a stock, this is not personal, it’s just about protecting what you have earned.
Now that you built your wealth through concentration, it is important that you protect it by adequately diversifying your portfolio.
In subsequent articles, I will discuss specific strategies used when selling and diversifying your single stock positions.
Disclaimer: Diversification does not ensure a profit or protect against loss. Investing involves risk including loss of principal. No strategy assures success or protect against loss.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which course of action may be appropriate for you, consult your financial advisor. No strategy assures success or protects against loss.
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