Top 5 Tools for Managing Concentrated Positions
After a prolonged period of strong stock market performance, many investors find that their portfolios have grown far more concentrated than they intended. This trend is most visible in U.S. large cap growth stocks tied to technology and artificial intelligence, where a small group of companies known as the “Magnificent Seven” has driven an outsized share of market returns in recent years. Positions that started as modest investments years ago can now make up most of an investor’s overall wealth.
Unlike certain investment risks that investors may expect to be compensated for over time, concentration risk generally does not provide an expected return premium. Concentration is therefore an unproductive risk, but addressing it is a real challenge, especially when the position sits in a taxable account. Selling outright can trigger a large capital gains tax bill, so investors often look for alternatives. Here are five tools that a concentrated investor might consider.
Section 351 Exchanges
In certain circumstances, a Section 351 exchange may allow investors to contribute appreciated securities to a qualifying structure that can result in ownership of a more diversified portfolio without an immediate taxable event. The appeal is immediate diversification with no current tax cost. Limits apply, however: To keep the exchange tax-free, no single stock can make up more than 25% of the resulting fund’s value, and the top five holdings combined cannot exceed 50%, so not every stock or situation qualifies. When it fits, a 351 exchange can be a strong solution, particularly for investors holding concentrated shares tied to equity compensation.
Trading Exchange Funds
Traditional exchange funds work in a similar spirit but come with different trade-offs. Fund managers typically structure these funds as partnerships under Section 1031, allowing investors to exchange one or more stocks for an interest in a diversified pool of securities. Like 351 exchanges, these transactions defer taxes. Liquidity is the primary limitation: Investors usually need to stay invested in the partnership for several years, since funds typically impose lock-up periods, redemption fees, and redemption rules to preserve their tax treatment. Funds may also restrict certain names when too many investors try to contribute the same stock at the same time. Savant has also written about how a 1031 exchange works for real estate investors, a related use of the same section of the tax code.
Opportunity Zone Funds
Opportunity zone funds are another potential solution. Investors can defer tax on eligible capital gains by reinvesting the gain in a qualified opportunity fund within 180 days of sale. Holding the QOZ Fund for at least five years can reduce the taxable portion of that original gain. Remember that tax benefits are subject to legislative and regulatory changes. These investments focus on real assets such as real estate and infrastructure rather than public equities, so they do provide diversification benefits. Investors generally use these as part of a broader portfolio rather than a full replacement for equity exposure.
Tax-Loss Harvesting
Investors who prefer a more gradual approach can use tax-loss harvesting to reduce concentration over time. This strategy often involves using an appreciated stock as collateral to borrow cash and invest in a diversified, market-neutral portfolio. Investors then harvest tax losses by selling any position that is trading at a loss and use those losses to offset gains from the gradual sale of the concentrated position. This approach can reduce the immediate tax impact, but diversification happens more slowly, and some exposure to the concentrated position remains during the transition. The strategy can involve borrowing costs, investment risk, leverage risk, and tax complexities, and may not be appropriate for all investors. Savant’s overview of tax-loss harvesting explains the mechanics and risks in more detail.
Options Strategies
Investors can also utilize options strategies alone or alongside these tools. Selling covered calls can generate income from a concentrated position, while buying protective puts can help limit downside risk. Call option income can help offset taxes as investors sell concentrated shares over time, though that income is itself taxable. Options strategies involve costs, market risk, and complexity, and may limit potential gains or result in losses.
Rarely does a single tool solve concentration risk on its own. In practice, managing this risk often means combining solutions and, in nearly all cases, includes the straightforward step of selling a portion of the position each year and paying a reasonable amount of tax along the way. Savant’s broader look at the case for diversification explains why spreading risk across positions matters even when markets are strong.
If you have questions about how these strategies apply to your situation, reach out to a Savant advisor to talk through the options.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