Managing Concentrated Stock Positions

Living in Seattle and primarily working with individuals and families in the tech industry, I’m very in touch with our burgeoning tech scene. Industry titans such as Amazon, Microsoft, Facebook, Apple, and Google, all have large offices here. If you work in the tech industry you’re also likely familiar with the variety of equity compensation structures many of these companies provide. These forms of equity compensation and the resulting wealth it’s provided for the thousands of employees has been life-changing. However, one obstacle that often presents itself when a large part of your compensation is derived from your employers stock is concentrated stock risk. This article will explore the various strategies to use when managing concentrated stock positions, the importance of diversification, and using concentrated stock to achieve your financial goals!


What Qualifies as Concentrated Stock?

There’s no particular percentage that a single stock position has to carry for it to receive the “concentrated stock risk” designation. When evaluating a client’s overall investments, net worth, and other factors, I evaluate the RISK that one particular position carries as it pertains to the client’s ability to achieve their goals. If carrying a single stock position significantly affects your ability to achieve any short term or long term goals, then you likely have concentrated stock risk that needs to be addressed.

For example, a Microsoft employee has received several stock grants and subsequent vesting over the course of a decade while also participating in their ESPP program. The resulting financial picture that’s developed for the employee is $1m in Microsoft stock and $200k in other investments with a total net worth just over $2 million (when accounting for home value). It’s clear from this picture they’re carrying a significant amount of risk by holding a single position in Microsoft stock because it makes up almost half of their net worth. Instead, diversifying the Microsoft stock to other industries, sectors, market caps, etc. would reduce the risk and enhance the ability of this person to achieve whatever it is that’s important to them.

On the other hand, an early Amazon employee with $1 million in low basis (meaning they recieved/bought the stock at a low price relative to today) but with an overall net worth of 10 million dollars, likely has the ability to live the life they want regardless of what occurs with the Amazon stock. In which case, they may choose to hold the stock for tax purposes and forward-looking growth prospects, donate to charity, or gift to family.

The key point being, concentrated stocks should be viewed from a holistic perspective. What really matters is your ability to live the life you want, and if that’s achievable without putting all your eggs in one basket, then it makes sense to put a strategy in place to reduce that risk.

How to Manage Concentrated Stock Positions

Every individual’s situation is different, and therefore strategies can differ. However, there are a few common ways to address concentrated stock positions such as selling covered call options, buying put options, using exchange funds, gifting, donating to charity, and of course plain selling the position to diversify.

Using Options to Hedge

First, a common strategy employed with concentrated stock is to “hedge” the risk a position will decrease in price, by using options. Options give the buyer the “right to buy” at a specified price and within a specified time frame. Option sellers, therefore, must agree to sell the position at a specified price and within a specified time frame if the buyer exercises their right.

If the goal for an individual with a concentrated position is to hedge the downside risk of the stock, they’ll want to sell a covered call option or buy a put option. When selling an option, you also collect a premium which in effect decreases your downside risk by the amount of the premium. When buying a put option you can hedge a particular percentage of the downside, say 20%. You’d buy enough put options to cover a 20% fall in your stock price. You’re limited to “losing” what you pay for the put options and anything above a 20% fall of the stock.

Using options is effective if you plan on selling off the concentrated stock over a period of time due to tax reasons, or if you fear the market is on the verge of a recession. It can be a complicated strategy to employ if you’re unfamiliar with options or have a strict insider trading policy with the concentrated stock in question. Luckily, Millennial Wealth helps with these sorts of “problems”!

Exchange Funds

Individuals in similar situations with concentrated stock may consider an exchange fund as a solution. Exchange funds pool investors concentrated stocks together in a “fund” to help them diversify their positions and minimize taxes, effectively reducing the risk. However, the downside is the investor has no liquidity and oftentimes pays high fees. There’s also no guarantee the investor wouldn’t be better off hedging their risk while they sell off the stock position over time, which also would provide liquidity.

Gifting or Donating to Charity

If you’ve found yourself in the position where your concentrated stock is a “bonus” in regards to your ability to live your best life and achieve all your financial goals, you may consider gifting the stock to family or charity.

If this is a priority of yours, it’s advantageous for tax purposes as well, to gift highly appreciated and concentrated stock instead of cash or other investments. The receiving person of the gift will inherit your cost basis (the price the stock was purchased at), however, it avoids you having to pay taxes when selling the stock.

If gifting to charity, you’ll also receive a reduction in tax liability for that year. Using a donor-advised fund as a way to create a legacy of gifting is a great tool to help educate the family as well. You can all participate in grant decisions and meaningfully have an impact on not only the charities you end up donating to but in creating that charitable inclination within your family.

One very impactful strategy that can be employed if gifting is a goal – is to frontload a 529 plan for a family member. 529’s are education savings accounts used to pay for K-12 private schools or college education expenses. In any given year, you can contribute up to 5 years worth of the annual gift tax. That could amount to as much as 75k dollars or 150k for married individuals! That’s an extremely impactful way to gift in my opinion!

Selling and Diversifying in Other Investments

Lastly, the most obvious way to reduce the risk of concentrated positions is to sell the stock and diversify it into other investments. The downside is you’ll likely owe Uncle Sam a significant sum, especially if it’s got a low-cost basis. Balancing the tax consequences of selling concentrated stock is key in making this decision. Even if it all qualifies as long-term capital gains (20% max tax bracket on the sale) you’ll likely “push” yourself into a higher income tax bracket, which is increased by realized capital gains, even though capital gains are taxed differently. In turn, you end up paying more on your ordinary income as well.

Being strategic and utilizing a variety of these strategies is typically the best way to go about managing a concentrated stock position.

Using Concentrated Stock to Achieve Your Goals

In the end, I always say- these decisions should all be guided by what’s truly meaningful to you. Are you able to live the life you want? Achieve all your financial goals? If it’s necessary to reduce the risk that a concentrated stock presents in order for it to be MORE LIKELY to achieve your goals, then it should be a priority to do so.

Lastly, dealing with concentrated stock likely means you’re in a solid financial position that provides flexibility. If you need help putting a holistic financial plan in action, articulating your goals, and managing concentrated stock positions, don’t hesitate to schedule a meeting, it’s what we do!

Levi Sanchez

Levi Sanchez is a CERTIFIED FINANCIAL PLANNER™, BEHAVIORAL FINANCIAL ADVISOR™ and Founder of Millennial Wealth, a fee-only financial planning firm for young professionals and tech industry employees. Levi’s been quoted in the New York Times, Business Insider, Forbes, and is a frequent contributor to Investopedia. He is an avid sports fan, personal finance and investing geek, and enjoys a great TV show or movie. His mission is to help educate his generation about better money habits and provide financial planning services to those who want to start planning for their future today!