Managing Concentrated Stock Risk: From Concentration to Confidence

Speaker 1 – 00:00
I have actually printed out here best performing stocks in the S&P 500.
Speaker 2 – 00:04
People don’t really know those companies have been working on AI the last 10 to 15 years. We’ve seen a lot of
situations where people have done this and we’re very concentrated in a sector or a company and those things can
overnight drop 50, 60%.
Speaker 3 – 00:19
If you have a position that has done so well for you over the last 10, 15, 20 years, it’s so hard emotionally to get rid
of it because it’s been so good to you.
Speaker 2 – 00:30
Let’s protect the wealth. And so definitely some careful planning needs done.
Speaker 3 – 00:34
And so one of the strategies that we do, I’ll start with direct indexing.
Speaker 1 – 00:37
The strategy is it’s called nua which is net unrealized appreciation if you’re charitably inclined.
Speaker 3 – 00:42
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A donor advised fund makes a lot of sense.
Speaker 2 – 00:44
An ETF tax free swap. So essentially there’s generally minimums to do this.
Speaker 3 – 00:49
If you feel like you’re in a lower income year it could be a good time to realize some tax favored strategies.
Speaker 2 – 00:55
Concentration is a really great way to get rich is the way to stay rich.
Speaker 3 – 01:06
So Jameson, right now The S&P 500 is really dominated by the Mag 7, the Teslas, the Alphabets, the Metas, et
cetera. A lot of people have a lot of exposure in large cap in the S&P 500 and a lot of people have exposure in
those individual positions as a whole for analyzing people’s portfolios we’re seeing sometimes holdings in the 50
to 60% range of someone’s overall net worth. What’s the problem with that? And then we’ll just get into some
strategies for those types of situations.
Speaker 2 – 01:34
Yeah, so I think really if you look back at the last 25 years of the S&P 500, it’s been like I think the biggest booming
period ever. And one of the biggest reasons is for the wealth creation with AI and tech. So obviously there’s the dot
com boom, cell phones, Internet and then really the last people. People don’t really know this but the last like 10 to
15 years has really been as long as these companies have been working on AI. It’s really just been the last like
three years that it’s been in headlines with ChatGPT being released. And so we’ve seen this big wealth creation
opportunity of people that have invested in these in the Mag 7s that you have explained we will it continue? We’re
not going to speculate.
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Speaker 2 – 02:20
It might but we’ve seen a lot of situations where people have done this and now they’re nearing retirement. And
what the problem is, number one, we’re very concentrated in a sector or a company and those things can overnight
drop 50, 60%. The second thing is, from a tax standpoint, it becomes a very big tax problem on how you’re going to
actually unwind this because not only are you juggling taxes, but you’re also juggling the risk of that sector or stock
getting cut in half and you have to sell it to live on. Then you have to pay tax. There’s a ton of issues that come with
this and so definitely some careful planning needs done.
Speaker 3 – 03:05
Before we jump in, I just wanted to say there’s going to be a lot of financial strategies that we’re going to have, a lot
of tax saving strategies that we’re going to have. But almost a bigger issue is just the emotional side of this. I
mean, if you have a position that has done so well for you over the last 10, 15, 20 years, it’s so hard emotionally to
get rid of it because it’s been so good to you. Sometimes you’re, we’re talking with people that work for a company
that have a bunch of company stock and it’s just, you know, it’s their salary, they believe in the company, they’ve
been there for years. Same thing with holding one of these individual positions. They’ve been a believer in it for
years. So it’s hard emotionally to unwind that position.
Speaker 3 – 03:44
But mixing emotions and investing, it’s like oil and water. You really gotta, you really gotta avoid it if you can.
Speaker 2 – 03:50
Yeah, that’s a really good example. I think it’s a really good place to start is before we even get into the technical
side, we gotta understand the emotions and the psychology behind it. So a lot of people are emotionally tied to
these. It’s created a lot of wealth. I like to frame it as concentration is a really great way to get rich. Diversification
is the way to stay rich. So when you’re trying to accumulate wealth, you kind of need to find. You don’t need to. But
a lot of people will get wealthy by finding that needle in the haystack. You’re finding this one thing that’s going to
get me really wealthy. Once that occurs, now we need to just buy the haystack. We don’t need to take these bets on
these individual things.
Speaker 2 – 04:28
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We just need to own everything or as much as we possibly can, which is a good analogy for diversification. But I
think before we get into the tactical stuff, it’s really creating a decision making framework of we’re going to make
the decision now before emotions get involved, of stocks up, stocks down, because that’s when people get
emotional. We’re going to make the decision now and set this framework of hopefully the market’s up, because
you can usually people a little bit more euphoric. But we’re going to make this decision now of some exit strategy
of whether it’s every quarter, every year, every six months, every month, it doesn’t matter what the market’s doing,
we’re going to just get out of this position in a systematic way that is not tied to your emotions.
Speaker 2 – 05:10
So that would be one framing and the second framing is what do you need to secure your financial goals? So how
much money do we need to be diversified to make sure that college, if that’s still in the picture, financial
independence, legacy, all that stuff is in place and then beyond that, we can invest however we want. So, Ben, give
an example of like how we would make those types of decisions.
Speaker 3 – 05:34
Before I do that, just one more note on the emotional side of things. This all comes back to theory of just regret
minimization. Like oftentimes we’ll walk. I’ll. I love this example. Let’s say a client has like $2 million worth in a one
stock position. You can ask them, hey, what would evoke a stronger emotion from you if you sold it and it went
from 2 million to 3 million and you missed out on that million dollar growth? Or if you didn’t sell it and it dropped
from 2 million to 1 million, what would make you feel stronger? And I think nine times out of 10 people will say,
well, I would feel stronger if it went from two to one and I didn’t do anything than if I sold it and it went from two to
three.
Speaker 3 – 06:13
So it’s just this idea of getting clients to wrap their head around the idea of selling it just in the sense that we want
to make sure that we’re taking the almost like opening the door that is going to make them feel better than in those
two options. So I always like walking clients through that.
Speaker 2 – 06:29
Basically the downside’s worse than downsides, worse than the upside downside of a double or 3x or something.
Speaker 3 – 06:33
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Exactly, exactly right. And so one of the strategies that we do when we get people to think, okay, I’m ready to take
some chips off the table, first things that we like to do is, you know, I’ll start with direct indexing. It’s a tax loss
Harvesting strategy that mirrors index investing. It allows you to harvest losses from individual stocks as opposed
to ETFs or mutual funds. Those losses carry forward on your tax return indefinitely and you can use them really at
any time. So you can offset 3,000 of your income every year. But more importantly, you can just bank losses on a
carry forward basis forever. And so if you have loss carryforward, you can unwind a stock position that maybe has
a large capital gain, you can use those losses to offset it.
Speaker 3 – 07:18
If you have 100,000 of losses on your tax return and you’ve got $100,000 in a potential capital gain, if you sold a
stock, you can net those out and make it tax neutral. So that’s the first strategy that we see often that makes a ton
of sense for clients in this situation.
Speaker 2 – 07:34
And I’ll give an example. You know, if someone has $20 million and it’s heavily concentrated, well, let’s say they
spend, I don’t know, $300,000 a year just to live. $10 million supports that. So we would say let’s take 10, get it off
the table and support your life. And this other 10, we’re going to come up with some sort of exit strategy or leave a
portion of it invested if you want to participate in the upside. So direct indexing tax on servicing is definitely very
effective way to do that. We’ll give you some more details on that with Drew. If a client has, let’s say they don’t have
this stock in a brokerage account, they have it in a retirement account, what are the tax implications and what are
some strategies to minimize taxes on the strategy?
Speaker 1 – 08:18
It’s a good question. The strategy is it’s called nua, which is net unrealized appreciation. And basically what
happens is if it’s only done in a 401k or an ESOP, but if a employee has a concentrated stock, their own company
Stock In a 401k, let’s just say 50,000 of cost basis and 150,000 of, you know, gain. So the overall 200,000, what
they can do is they can move it to an individual brokerage account in kind and then pay taxes, ordinary income on
just the basis of the 50 grand. And the other 150,000 would be taxed at long term capital gains, which would save
them a lot of money.
Speaker 2 – 09:04
So if they didn’t do that, they’re going to take it out of income rates.
Speaker 1 – 09:08
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Correct.
Speaker 2 – 09:08
Which would be, you know, 24, 32, 35, 37%. Or in that example, they take it out, pay income tax on the basis and
then everything else going forward is treated as a capital gain. And they don’t have to sell it. Do they have to sell it
immediately or can they hold it?
Speaker 1 – 09:24
They can hold it, but yeah, majority of them do sell it in the individual brokerage account.
Speaker 2 – 09:30
So that’s a strategy if it’s in a 401k.
Speaker 3 – 09:33
And just to be clear, the 15% long term capital gains rate ends at about $600,000 of income if you married filing
jointly. So if you’re in that range, 15% long term capital gains versus 32 to 35% ordinary income is pretty significant.
Speaker 1 – 09:48
Right. There are some triggering events for that. You have to be 59 and a half or there could be a death which the
beneficiary can do that, or disability or separation from service. So that’s basically leaving, retiring or being fired.
Speaker 2 – 10:04
So good strategy. If it’s in a 401k and then so get fired.
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Speaker 3 – 10:07
That’s, that’s the no, get fired and.
Speaker 2 – 10:10
Move your stock up. So if it’s in a taxable investment account, Ben hit on direct indexing and tax loss harvesting.
So ideally carve off some that you can direct index, rack up as many losses as you can and then slowly erode the
concentrated holdings to offset those losses or offset the gains. Another strategy is just fire sale and if it’s in a
gain, sell it, pay your taxes and move on. That’s really hard for people to do because they’re generally pretty tied to
this emotionally, but can be a viable option depending on net worth.
Speaker 3 – 10:41
I think just peace of mind. I think that goes a long way for clients. It’s just, I use the analogy of just getting chips off
the table. I mean if you’re paying capital gains tax, that means you did something right, like you’ve got a gain and
just, you know, take some of that risk. It’s a good thing. Exactly. So I just try to frame that, you know, it’s hard to
wrap your head around, but if you can frame it like that, it does make a lot of sense.
Speaker 2 – 11:02
I’m not much of a gambler, but if you’re sitting at a blackjack table and you put a hundred dollars in and now you
have chips of $1,000 sitting there, probably want to take some of them and put them in your pocket.
Speaker 3 – 11:15
It’s so funny you say that. I’ll sit with people at a blackjack table, they’ll buy in for a certain amount and then they’ll
have winnings and then they’ll put their buy in like almost on the side because they want to just play with their
winnings and they know like okay, well if my winnings go away, I still have what I bought in. Invest. People don’t
think of their investments like that. People don’t think of, well, I, I only want, you know, I want to protect my basis on
my investment side. A lot of people don’t think it, think like that. So it’s the same exact scenario as playing with
winnings in your blackjack table, knowing that you’ve got your buy in on the side versus selling off a portion of your
appreciated stock, knowing that your basis is still there.
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Speaker 2 – 11:54
I’d view your basis as what number do you need to support your goals? So that number is 5 million to support
financial independence. Whatever the goals are, that’s what you take off the table and invest the rest in whatever
you want. Okay, why don’t we talk about donor advised fund and how charity can come into play.
Speaker 3 – 12:16
This is huge. If you’re charitably inclined, a donor advised fund makes a lot of sense. Think of a donor advised fund
as basically an investment account that has to go to charity. And so really good things to think about when you’re
putting money into a donor advised fund is taking low basis stock that you’ve held for a really long time or stock
that’s got a really big gain on it. If you move that position into a donor advised fund, you get an immediate income
tax deduction on the amount in which you put into the donor advised fund. So if you put 250,000 into a donor
advised fund that year when you file your taxes, you’re able to get that income tax deduction of 250,000. If you’re in
the highest tax rate, that’s 37% off that 250 that you’re saving.
Speaker 3 – 12:59
But more importantly, you’re avoiding the capital gains. Had you had just sold the stock and donated the cash
proceeds to the charity itself. So if you’ve got a, Your basis is 50,000 and your market value is 250, you know that’s
a $200,000 capital gain that you’re avoiding because the charity receives it completely tax free. So that’s kind of a
two way tax benefit to the donor advised fund. It also allows you to take a big itemized deduction the year in which
you do it. So it’s. If you’re charitably inclined and you’ve got a stock that you’ve held for A really long time. A donor
advised fund makes complete sense. The only kind of caveat here is that once the money is in the donor advised
fund, it has to go to a charity. You can’t kind of pull it back into your ownership.
Speaker 1 – 13:41
It’s a good way of educating your kids too on helping out and giving to the charities along the way.
Speaker 2 – 13:49
So yeah, donor advised fund is a good option. So let’s talk about if you don’t do that and you’re not charitable and
you’re just going to hold the stock. So you could sell the stock and pay capital gains taxes, you could hold the
stock and die. So one recommendation could be to die. I’m just kidding, don’t do that. And you get a step up in.
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Speaker 3 – 14:10
Basis to explain that though, because that is.
Speaker 2 – 14:14
So if you have a stock that has a million dollar basis, it’s 2 million. And while you’re living, you sell it, you pay taxes
on that million dollar growth. If you die and it goes to children. Now, their basis instead of it being 1 million is 2
million. And then they pay taxes, anything going forward.
Speaker 3 – 14:31
So if they hold it and it goes from 2 million to 2 and a half million, their gain’s only 500,000. Whereas if you know, if
they don’t have that original million dollars that you had so big tax, or.
Speaker 1 – 14:43
If they sell it, you know, after you die, they barely pay any tax, which is huge.
Speaker 2 – 14:47
That does not apply if you gift it and it does not apply if it’s in a trust. So irrevocable trust. Other options are, you
can do this a little bit more complicated but can be done. It’s called an etf, Tax free swap. So essentially there’s
generally minimums to do this. Like I don’t know what it is, might be a million, a couple million, five million. But you
essentially, let’s say you have some stock that you have a big concentrated position, you have a million dollar
basis, it’s worth 5 million. You can take that stock and give it to a fund manager, ETF or mutual fund. And in
exchange for that stock goes into the fund and you get the same market value of that etf. So what does that do for
you?
Speaker 2 – 15:36
Number one, you don’t have to sell it and pay taxes immediately, but it gives you an instant diversification. So for
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example, let’s say you had, I don’t know, one of these Mag 7 tech companies, you exchanged it into, let’s say QQQ
for example, which is an index that follows tech. Now instead of holding that one position of $5 million. You now
have $5 million in this tech ETF which gives you some diversification. You’re not heavily country that one company.
You still have the same basis. And I would say the main reason that this would make sense is if you say, okay, I
have money that’s going to go to children and I want to get that supplement basis. I don’t want to sell this, but I
also don’t want this stock to get cut in half.
Speaker 2 – 16:15
So exchange it, get some diversification, it appreciates and then it goes to kids to tax free or with a step up in basis
and then what other strategies?
Speaker 1 – 16:28
This is not, this one’s not a strategy. But I have actually printed out here best performing stocks in the s and P500
over five years. 10, 15 and 20. And just to kind of give people an Idea, over the 20 years, Nvidia is up 75,000% in the
last 20 and in the last five it’s up, you know, almost 1200%. So when we talk about concentrated positions, there
are many people that have these concentrated positions. I’ve been asked many times, you know, when do you sell
or when do you get out of it? I’m not here to kind of guess just because of, you know, over the last 20 years it’s
been up 72,000%. So it’s more from my end. It’s more time in the markets. Better than timing the market, keeping a
financial plan and doing what’s right.
Speaker 2 – 17:20
Yeah, no, that’s a good point is yeah, you can’t tell what’s going to happen. And I would say if the stocks
accumulated a bunch of wealth, it did what you wanted it to and now let’s protect the wealth. There are some
option strategies that we won’t get into all the details but you know, you could not an option but you just put a stop
loss on it would be one. So you say, okay, stock’s trading $100 a share. If it hits 90, it’s just going to trigger and sell.
That takes the emotion out of it. If you do an option strategy, like one way would be a use a covered call. And so
that would generate some income.
Speaker 2 – 17:55
It would trigger a sale at certain prices and as a way just to hedge the risk of that concentrated position while still
creating an income strategy. So that’s a little bit more nuanced and there’s a bunch of different ways to structure
options. You really need to understand the options and then make sure you get one that fits your goals.
Speaker 3 – 18:17
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Yeah. And that’s a good, I would say that’s a good choice for people that don’t want to sell the position, like want to
keep tracking it, but at the same time you’re almost putting guardrails on how much you can earn versus how
much you can lose. So if you put like a, an option on like a covered call and the stock shoots up, well, you may be
limiting some of your upside there, but more importantly you’re limiting the downside if it completely shatters. So
good option for someone that wants to stay involved in the stock as opposed to selling it outright.
Speaker 1 – 18:47
And the, one of my other clients, it’s a, it’s kind of a good point is sometimes it matters of which account you put it
in. Because were doing Roth conversions for a while and this client wanted to put, you know, 5 or 10% of a
concentrated stock in the Roth and what happened is kind of lucked out, took off and now it’s all tax free in the
Roth, which is huge.
Speaker 2 – 19:13
Yeah, definitely. If you can position into a tax advantaged account, that’s your best bet.
Speaker 3 – 19:18
Yeah.
Speaker 2 – 19:20
Anything to add that we missed?
Speaker 3 – 19:23
I would say, I mean just one other thing. It’s small and it’s, it’s relevant only in certain scenarios. But if you’ve got
someone that’s taken a sabbatical or like they’re just in like a lower income year that you know your 15% capital
gains rates up to $600,000. So if you’re in a much lower income year than maybe you have been in the past or
expect to be moving forward, any stock that you sell in that year, you’d be at a 15% capital gains rate as opposed to
a 23.8. You know, anything over that. So just, just monitor your income. If you feel like you’re in a lower income
year, it could be a good time to realize some tax favored strategy there.
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Speaker 2 – 20:00
Yeah, definitely. Spreading it out over income years can be an effective strategy. You just have to balance the risk
of we don’t want to wait on this and it drops 50% and now our goals are off track. It’s a delicate balancing act and I
would say to sum it up, number one, make sure your goals are supported with properly diversified portfolio.
Number two, a good rule of thumb is keep These holdings under 10% of your net worth. And again that’s net worth
depending and goals depending, but that’s a good blanket rule of thumb. And then don’t keep one stock that’s more
than like 5% of your allocation is generally good. Good rule of thumb as well. So we’ve seen this becoming more
and more common just because of this tech and AI boom that we’ve seen over the last 10 years, really.
Speaker 2 – 20:44
So if you have any of these complex decisions to make on how to exit, feel free to reach out. We’ve come across
this a number of times and look forward to looking for a solution that best fits your goals.
Speaker 1 – 20:55