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August 17, 2012
It doesn’t matter how you got here, but here you are, nearing retirement with a large portion of your wealth tied up in one company’s stock. Perhaps you picked wisely years ago – a Coca-Cola Co., Wal-Mart Stores, Inc. or Microsoft Corp. – and have had a wonderful ride. Or you simply accumulated a large holding of your company’s stock through employee options or your 401(k). Now you face a dilemma.
Should you hold? Sell? Hedge? Diversify? Or at least begin diversifying?
There is no easy answer, because no two investors face precisely the same circumstances. If the concentrated position forms a significant but not overwhelming portion of your wealth, you may decide to hold – fully aware of the high risk of doing so – or hedge. You may decide to diversify, investing in an exchange fund or using a charitable remainder trust (CRT). Tax consequences vary.
Whatever your decision, try to escape the psychological baggage that adheres to every investment. Discard the idea that the future is sure to repeat the past. There may indeed be high return potential from the right stock, says one study, but “significant underperformance is four times as likely.” Step back from your holdings and analyze objectively your most suitable options. If you decide to diversify, you still must decide on how to accomplish that.
Diversifying in planned stages is a possibility. That allows you to keep upside potential in the stock while meeting your spending needs. Keep in mind that any timed strategy prolongs your risk exposure to this single stock. If you believe your investment horizon is long enough – taking age, health and goals into account – selling a substantial portion of your holdings and paying the taxes may be the best strategy, because, over time, your newly diversified portfolio will have time to outstrip the tax burden.
If you intend to use a significant portion of your wealth for philanthropic purposes, consider a CRT, through which you will receive a charitable tax deduction. The CRT will sell your concentrated position tax-free and arrange a (taxable) income stream to you from its newly diversified holdings.
If you find yourself holding a concentrated stock position and want to explore the most advantageous ways of dealing with it, please give us a call at TBT Financial Services.
Diversification does not ensure a profit or protect against a loss.
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