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Strategies to Own a Concentrated Stock?

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Own a Concentrated Stock Position? Our 5 Strategies to Help Manage Risk and Taxes

Stock compensation can be a wonderful complement to a traditional compensation package, oftentimes contributing significantly to an investor’s net worth. However, there is an overlying risk to investors who have too much of their net worth concentrated in the stock of one company. This is more complicated if this stock has appreciated to an extent that selling would result in a substantial capital gains tax liability.

How can an investor mitigate the risk of having too much of their net worth concentrated in a single appreciated stock, and avoid significant tax liabilities? 

Multiyear-Sales Strategy 

Some investors may feel that the solution to owning an overconcentration of stock in a single company is simple: sell all of the stock and reinvest the proceeds in a diversified portfolio. While this strategy has the obvious benefit of immediately eliminating the overconcentration risk, the tax “hit” of utilizing this strategy can be substantial – especially considering that investors who received the stock as compensation may have a very low (or no) cost basis in it.

One approach to mitigate the tax impact of these stock sales is to amortize them over a period of two or three years. While this will not reduce an investor’s risk exposure as quickly as an outright sale, this strategy has the advantage of spreading the capital gains taxes over a multiyear period – allowing an investor to better control the timing of the capital gains with the goal of realizing more of these gains in relatively low tax years.  

 Put Option or Protective Equity Collar

A put option gives an investor the right to sell a stock at an agreed upon price on or before a particular date. The advantage of owning a put option is that it establishes a “floor” price at which the investor will be able to sell a stock position. This greatly reduces an investor’s downside risk, while at the same time allows them to retain the unlimited upside.

Instead of paying “out-of-pocket” to cover the premium (cost) of the put option, an investor can simultaneously sell a call option, which gives the purchaser of the call option the right to buy the stock at an agreed upon price on or before a particular date.

The strategy of simultaneously buying a put option and selling a call option is known as a protective equity collar. The potential drawback of an equity collar is the investor is now limited on the upside of the stock price as well. However, understanding that the premium from selling a call option will often cover the entire premium to purchase the put option, an equity collar can be a low-cost approach to hedging a concentrated stock position. Buying and selling options is best handled by a financial professional working on your behalf. 

Pool Shares into an Exchange Fund 

Exchange funds are private placement partnerships where an investor contributes a concentrated stock position into a fund that includes a mix of other stock positions. Oftentimes, these other stocks were donated by investors that had the same intent of diversifying their own appreciated stock positions.

With exchange funds, each investor receives a pro-rata share of the partnership (measured in units) based on the value of the stock that they contributed.

While one obvious advantage of an exchange fund is immediate diversification, an additional appeal of this strategy is that capital gains taxes are deferred until the investor sells their fund units. 

There are several important disadvantages of exchange funds, such as the typically high fund management fees, the lack of control over the other stock positions in the fund, and the lock-up period before an investor can sell their units (which is often as high as seven years). Further, exchange funds are regulated private placements, so they are typically subject to investment minimums and only available to investors that meet certain net worth thresholds.

Variable Prepaid Forward Contract

A Variable Prepaid Forward (VPF) contract is an agreement that an investor will sell a specific number of shares at a discount (usually between 75-90%) at a pre-specified future date in return for an upfront cash payment.

The “variable” in the term VPF refers to the fact that the shares the investor is selling at a future date are not fixed and are dependent on the performance of the stock. A lower stock price results in more shares sold to satisfy the obligation and a higher stock price results in fewer shares sold.

The benefit of a VPF contract is the immediate liquidity received from the cash advance. In addition, the use of the VPF contract allows for the deferral of capital gains – as the variability of the shares to be sold means that a VPF contract is not deemed a constructive sale by the IRS until the shares are delivered. However, in order to avoid IRS scrutiny, a VPF contract should be drafted by a qualified tax professional or lawyer. 

Charitable Gifting

While charitable gifting is a broad category that requires further in-depth discussion, there are several charitable gifting strategies an investor can utilize to reduce the risk of an overconcentrated stock position.

The simplest strategy is for an investor to donate the overconcentrated stock position to a charity (or charities) of their choice. Not only will an investor generally receive the same exact 

tax deduction as if they donated cash, donating stock has the dual benefit of eliminating the capital gains tax that would be associated with selling the stock outright. 

In our view, donating stock is a great way for an investor to both reduce their concentrated stock position and fulfill their charitable intentions.

Pairing this with a Donor-Advised Fund (DAF), a charitable investment account, can streamline the process of gifting stock and has the added benefit of allowing an investor to control the timing of both their tax deductions and their donations.

There are also different charitable trusts that may be appropriate for an investor with an overconcentrated stock position. These types of trusts, which include a Charitable Remainder Trust (CRT) and Charitable Lead Trust (CLT), allow an investor to better control and customize the charitable strategy that works best for them.

Charitable trusts come with material costs and added complexity, and we recommend you work with an experienced estate planning attorney and your financial advisor to determine the best choice for you.

How Can We Help?

At Towerpoint Wealth, we are a fiduciary to you, and embrace the legal obligation we have to work 100% in your best interests. We are here to advise you, and will work with you to decide the optimal strategy for your concentrated stock position. 

If you would like to discuss further, we  encourage you to call, 916-405-9166, or email to open an objective dialogue.

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No Outcome? No Surprise. No Problem!

We expected it to be this way, right? Historically, the market has always gotten a bit crazy both before, and after, the election:

Since Election Day on Tuesday, the S&P 500 has rallied 4%, and has enjoyed its best start to the month of November ever, up 7.4% in four days.

At Towerpoint Wealth, we believe there are a few reasons for this big jump:

  1. While investors do expect a fiscal stimulus package out of Washington D.C. in the near future, perhaps before January, the size of a deal reached in a divided Congress is likely to be much smaller than it would be under a Democratic-controlled Congress. However, sometimes bad news equals good news on Wall Street, and this had led investors to believe that more pressure will be on the U.S. Federal Reserve (“the Fed”) to pump more funds into the financial system, theoretically supporting stock prices. Just yesterday, Fed Chair Jerome Powell said more stimulus is “absolutely essential” to economic recovery.
  2. Assuming Republicans hold the Senate, the likelihood of significant increases in both regulations and income taxes is significantly decreased.
  3. Interest rate and inflation expectations have recently dropped:
         Interest Rates       

Additionally, as the Chart of the Week towards the bottom of this newsletter indicates, gridlock has historically been good for the equity markets. And while ballots are still being tallied, and Arizona, Georgia, Nevada, and Pennsylvania remaining in focus, it does appear that Joe Biden is on the brink of victory, and that we are much closer to having a clear winner, possibly by tomorrow or Sunday. The betting markets on the Presidency sure seem to agree:

There are many reasons for us here at Towerpoint Wealth to be paying close attention to events out of our control, but no reason to be reactionary to any of them. In addition to the recent interest rate and inflation-expectation adjustments, some of the other post-election, split-Congress items bearing scrutiny include:

  1. Renewed weakness in the financial sector
  2. Growth stocks outperforming value stocks
  3. Industrial and materials sector stocks lagging
  4. The volatility of the U.S. dollar
  5. Strengthening emerging market stocks
  6. Continued strengthening of technology sector stocks
  7. Potential weakness in tax-free municipal bond prices
  8. Weakness in healthcare sector stocks
  9. Weakness in renewable energy stocks

All of these moving parts and variables can make it tempting to consider second-guessing your investment strategy and philosophy. The constant struggle between the desire for growth and protection is natural, and the goal of managing a well-diversified portfolio is to be prepared for any market environment or political change.

Ultimately, when we put aside all of those “uncontrollables,” we keep the following graph in focus (hopefully the trend is an obvious one):

What’s Happening at TPW?

The Towerpoint Wealth family enjoyed an afternoon of teambuilding and camaraderie on the Sacramento river earlier this week, taking a quick voyage on the Sacramento Brew Boat up and back to the iconic Virgin Sturgeon restaurant for lunch.

While on their adventure, they also helped our newest family member and wealth advisor, Matt Regan, celebrate his birthday!

TPW Service Highlight – Morningstar Portfolio “Instant X-Ray”

Often enough, clients ask us what stocks they have exposure to within the various mutual funds and exchange traded funds (ETFs) that comprise their portfolio. We now have a sophisticated tool available to us that not only does a deep-dive in evaluating your specific asset allocation and sector weightings, but also the actual individual underlying holdings you have exposure to.

Think you are properly diversified? There is only one way to find out for sure – ask us to run a Morningstar portfolio Instant X-Ray report, and we will dissect your portfolio to uncover concentrated positions, areas of unexpected overlap, and provide detailed insights into your portfolio’s diversification, illuminating what is truly driving your portfolio’s risk and performance.

Chart of the Week

The odds right now seem to favor a Biden presidency, a Republican Senate, and a Democrat House. The chart below, from LPL Financial Research, shows how a split Congress has been historically good for the stock market.

As always, we sincerely value our relationships and partnerships with each of you, as well as your trust and confidence in us here at Towerpoint Wealth. We encourage you to reach out to us at any time (916-405-9140, with any questions, concerns, or needs you may have. The world continues to be an extremely complicated place, and we are here to help you properly plan for and make sense of it.

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– Steve, Jonathan, Lori, Joseph, Raquel, Nathan, and Matt

Towerpoint Wealth Our Team Sacramento Wealth