Concentrated stock holdings refer to a portfolio with one, or a few, company stock positions that make up a large percentage of a person’s total portfolio. These stock holdings may be obtained through employee stock options, family inherited or grown in value over many years.
At Stonebridge Capital Advisors, we often work with C-level clients who ask, “What about my concentrated stock, do I need to sell it?” We maintain that “holding a concentrated (undiversified) stock portfolio can significantly increase risk.”
From this response our portfolio managers will typically receive a flurry of follow-up questions. Because of this, we have put together responses as to how Stonebridge navigates the complexity of concentrated stock.
C-Level Executive: “I do not want to take all of the capital gains in one year.”
Recommendation: A strategy can be put into place to sell stock over a period of years to limit capital gains in any one year, as well as balance gains against losses from other securities.
C-Level Executive: “I feel personally attached to the company because I was employed there or inherited the stock.”
Recommendation: In most instances, there is no reason the client cannot retain a reasonable percentage of the stock in their portfolio. However, there are more than ample examples of companies that at one time appeared to be safe long-term holds: General Motors, AIG, GE and Kmart. The objective is to build wealth and preserve it.
C-Level Executive: “Rather than sell the stock and incur capital gains now, I’m going to hold the stock until I pass away and pass it on to my children, providing them a stepped up cost basis.”
Recommendation: Under current law, a stepped up cost basis can make sense dependent upon the time frame. However, this presumes that the tax laws for inheritance will not change, potentially creating a greater burden for those inheriting the stock. It also presumes the stock held will maintain or increase in value. For example, General Electric’s stock price was $42 per share in 2007 was as low as $5 per share in 2008 and is now $31 per share … step up or step down?
C-Level Executive: “I do not want to sell all or a large portion of my concentrated stock, but I need income and the dividend does not provide what I need.”
Recommendation: Even if the client does not want to sell all of their holdings, begin a sell strategy and replace it with a more appropriate income producing investment. Implement a “covered call writing” strategy on a percentage of the stock to increase income to the client. When a client writes a covered call on the stock, he or she is selling an option to another investor, giving them the right to buy their stock at a specified price. If the stock hits that price, the investor that purchases the call can “call” the stock and buy it from the client. For the time frame the client has provided the call option to the investor, the client receives a premium (income) for the stock. This premium can pay income equal to 1 percent or 5 percent of the value of the stock, thereby increasing income provided by the covered call.
Portfolios with highly concentrated stock(s) carry risks that should be identified for clients. Fortunately, there are strategies that can be employed for the client to retain a reasonable allocation of the favored stock and provide diversification, income, protection of principal and/or growth of a princip