Strategies for Concentrated Stock: How to Reduce Single-Stock Risk Without Ignoring Taxes
A concentrated stock position is usually a sign that something went right. You joined the right company early, exercised options that climbed, or held shares through years of growth. The problem is that the same position that built your net worth can quietly become the largest risk to it.
Here is a test I find useful. Imagine you were handed the cash value of your appreciated stock tomorrow, with no tax consequences. Would you turn around and buy that much of the same stock? For many people, the honest answer is no. And when it is no, inertia, rather than conviction, is probably keeping the outsized stock position in the investment portfolio. However, a concentrated single-stock position carries risk that a diversified portfolio does not, and an individual stock may never recover from a significant decline.
There is no single right way to reduce a concentrated position. The strategies below fall into three groups: selling and reinvesting, giving shares away, and hedging risk or deferring the tax consequences of a sale. Most effective plans use a combination of these approaches.
Start With the Role the Stock Should Play
Before choosing a strategy, consider what role the concentrated stock should play in your broader financial plan. The answer may depend on near-term spending needs, retirement, estate planning, charitable giving, business or real estate investments, or simply how much exposure to a single company you want to retain. Assets intended for use within a few years should be managed differently from assets that can remain invested for decades. Those priorities help determine how much to diversify and how quickly.
Strategy 1: Sell and Reinvest
Selling and reinvesting is the most direct way to reduce a concentrated position. It reduces single-stock exposure while allowing you to redeploy the proceeds toward a diversified portfolio or other financial goals. How quickly to sell depends on the size of the position, its cost basis, the tax consequences, and your willingness to continue holding the stock.
Consider selling newly vested RSUs. If your RSUs are adding to an already concentrated position, consider selling newly vested shares as they vest and redirect the proceeds into a diversified portfolio or another financial goal. The value of the shares is already taxed as compensation income at vesting, so selling them immediately does not give up a tax benefit associated with holding them. Making the sale automatic helps turn holding into an active choice rather than a default.
Diversify gradually and deliberately. For shares with a low cost basis and a large embedded gain, selling everything at once can create a substantial tax bill in a single year. One approach is to divide the position into three parts: a portion to sell now for near-term goals, a portion to sell gradually over several years, and a portion to hold long term. The right mix depends on your goals, tax situation, and willingness to retain exposure to the stock. Many investors seek to reduce concentrated positions substantially, although the appropriate level of exposure to any one stock depends on individual circumstances.
Spread sales across tax years. Long-term capital gains are generally taxed at federal rates of 0%, 15%, or 20%, depending on taxable income, and may also be subject to the 3.8% net investment income tax. A large gain can push more of your gains into a higher capital gains bracket, increase state taxes, and affect deductions or other tax benefits tied to income. Selling part of a position in December and part in the following January splits the gain across two tax years and may reduce the total tax. This is not market timing; it is an approach that may provide tax planning flexibility in certain situations. For very large gains already taxed at the top rate, normal price volatility can matter far more than the tax savings.
Use a 10b5-1 plan if you are an insider. If trading restrictions or access to material nonpublic information limit when you can sell, a Rule 10b5-1 plan can establish a prearranged selling schedule and help reduce insider-trading risk. It can also help remove some of the emotion from individual selling decisions.
Use direct indexing to help offset gains. A direct-index portfolio owns individual stocks, which can create opportunities to harvest tax losses and offset some of the gains from selling a concentrated position. It can be funded with cash or with proceeds from sales of the concentrated stock. This may create opportunities to improve tax efficiency, especially when new money continues to be added. Over time, however, opportunities to harvest losses may decline as the portfolio appreciates. While loss harvesting may help offset some gains, it does not eliminate taxes and may not materially reduce the overall tax impact.
Strategy 2: Give Shares Away
If charitable giving is already part of your financial plan, appreciated stock can be an especially tax-efficient asset to give because you can avoid realizing the embedded capital gain. Family gifting can also play a role in some wealth transfer plans.
Donor-advised funds and charitable gifts. Donating appreciated shares directly to a donor-advised fund, rather than selling the shares and donating cash, may provide tax benefits, including the potential ability to avoid realizing the capital gain on the donated shares and, subject to applicable tax rules and limitations, claim a charitable deduction based on fair market value. When choosing which shares to donate, it often makes sense to use those with the lowest cost basis and largest embedded gain. A donor-advised fund also lets you bunch several years of charitable contributions into a high income year, when the deduction may be more valuable, while making grants to charities from the fund over future years.
Gifting to family. Appreciated shares can also be given to family members, particularly when wealth transfer is already part of the plan. The recipient generally takes your cost basis, so the embedded gain is transferred rather than eliminated. In some cases, future gains may be taxed at a lower rate, although gift tax rules and special rules for younger recipients can complicate the strategy.
Charitable trusts. For larger positions and long-term charitable goals, a charitable remainder trust can allow appreciated shares to be sold inside the trust without an immediate capital gains tax, provide an income stream, and leave the remainder to charity. These trusts can be powerful but are complex and irrevocable, so they should be considered with an attorney and financial advisor.
Strategy 3: Defer or Hedge
When an immediate sale is undesirable, other strategies can reduce the risk of a concentrated position or defer recognition of the capital gain. These approaches are generally more complex, less liquid, and more expensive than simply selling, so the trade-offs matter.
Exchange funds. An exchange fund lets you contribute concentrated stock to a pooled fund and immediately gain exposure to a diversified portfolio without triggering an immediate capital gain. You generally must remain in the fund for around seven years before you can exit and receive a diversified basket of securities, and the investment carries fees and liquidity restrictions. Availability can also be limited: if the fund already holds too much of a particular stock, it may not accept additional shares of that company. Exchange funds defer the embedded gain rather than eliminate it.
Collars and protective puts. For a position you want to hold longer, options can limit downside risk. A protective put provides downside protection at a cost, while a collar pairs a put with a sold call to help offset that cost in exchange for limiting some of the upside. These strategies add cost and complexity and can trigger tax issues, including the constructive sale rules, that should be reviewed with tax and financial professionals before proceeding.
Long/short portfolios. A long/short portfolio can be used to diversify a concentrated position over time while seeking investment returns from a broader portfolio. Appreciated stock, and sometimes other assets, can be contributed to the portfolio, which adds long and short positions across other securities. Along the way, the portfolio may generate tax losses that could be available to offset gains as portions of the concentrated stock are sold, although such outcomes are dependent on market conditions and portfolio results. The goal is not simply to generate losses, but the loss generation may provide offsetting tax benefits. Like an exchange fund, this generally defers, rather than eliminates, the embedded tax. These strategies can be expensive and complex, and they can become harder to unwind tax-efficiently over time as loss harvesting lowers the cost basis of the remaining positions.
Your Strategy Depends on Several Factors
The right approach depends on your cost basis, other income, state of residence, charitable goals, time horizon, and how much of the position you genuinely want to keep. Some investors may sell and diversify over time, others may give away appreciated shares, and still others may use exchange funds, hedging, or long/short strategies to manage the risk or defer the tax.
Timing matters as well. Shares may be approaching a long-term holding period or may qualify for the qualified small business stock (QSBS) exclusion under Section 1202, where selling too early can mean giving up a valuable tax benefit. Insider restrictions, an upcoming liquidity event, or other planning considerations can also affect when and how you diversify.
A concentrated stock position often reflects substantial investment success, but it also creates decisions that should be made deliberately. Start by deciding how much of the stock you want to keep and why. From there, you can build a plan for the rest, whether that means selling over time, giving shares away, or using more specialized strategies to manage risk and taxes. The goal is not necessarily to eliminate the position, but to make sure the amount you continue to hold is intentional.
If you are holding a concentrated stock position, whether from equity compensation, an acquisition or IPO, or simply an investment that has grown substantially, and you are not sure how to reduce the risk without creating an unnecessary tax bill, I work with technology professionals on equity compensation, concentrated stock, and tax planning. You can schedule a complimentary consultation directly.
This is intended for informational purposes only. You should not assume that any discussion or information contained in this document serves as the receipt of, or as a substitute for, personalized investment or tax advice from Savant. Please consult your investment or tax professional regarding your unique situation.
Bruce R. Barton
Managing Partner / Financial Advisor
CFP®, CFA®, MBA