Concerned About Concentration? You Have Options

When economies are stable, bull markets seem boundless, and concentrated stock positions look limitlessly profitable. But what happens in a reversal? Fortunately, investors can lessen exposure in several beneficial ways, depending on their goals.

Whether you’ve amassed large stakes in a single stock through vested employee awards, concentrated investment strategies, or an inheritance, recent market turmoil may give you pause. A large position that fueled your fortune when markets soared can suddenly become your Achilles heel during a downturn. What should you do now? The answer depends on what you’re trying to accomplish.

Give Me Shelter

While most stocks have seen pullbacks this year, some have been particularly painful—such as the recent 50% plus declines in certain energy, airline, and hospitality stocks. The drawdowns have devastated investors with a large percentage of their wealth in these names, while reminding us all that other stocks remain vulnerable to a similar fate.

As market uncertainty persists, does preserving wealth rank among your top concerns? Consider reducing concentrated stakes and reinvesting in a well-diversified portfolio instead. Diversified portfolios tend to exhibit less volatility compared to individual, concentrated stocks. For instance, the S&P 500 had fallen -9.3% year-to-date through April, while many individual names remain down much more.

But aren’t we out of the woods? After all, the market has risen substantially from March’s lows. Not necessarily. While the broad market has rebounded, many individual stocks have experienced uneven recoveries—and a few with weak balance sheets and high fixed expenses remain at risk for permanent damage. With that said, the recent rally may provide a much better exit price for your concentrated position.

On the other hand, the flip side also holds true. Diversified portfolios have historically lagged the outsized gains of some individual high flyers, so investors may be sacrificing some upside potential if they reduce their holdings. But switching to a well-diversified portfolio offers much better downside protection, while avoiding the all-or-nothing gamble that a single stock could become worthless overnight.

How much should you diversify? At least as much as you need to satisfy your “core capital”—our highly stress-tested, conservative estimate of the amount you will need to support lifestyle spending for the rest of your life. Because single stock concentrations are associated with higher volatility, our research indicates that reducing these positions significantly lowers the amount of core capital you require. The number varies based on individual circumstances, so consult your financial advisor for your personal core capital figure.

Sell vs. Donate

The tax liability triggered by large stock sales may be keeping some investors at bay. But most concentrated positions have fallen from their peaks, so if a high tax cost was holding you back—the potential hit has likely waned. On the other hand, many investors hesitate to sell at a loss, hoping to at least “break even.” Yet, selling now will recognize a tax loss, which creates an advantage by eliminating your tax liability on other capital gains. And if you do not have enough gains to offset this year, your net capital loss can be carried forward indefinitely to reduce future years’ taxes.

Alternatively, if you want to help support vulnerable populations or nonprofits hit hard by the shutdown, consider gifting appreciated stock (instead of cash) to charitable organizations or donor advised funds. Despite the recent sell-off, many investors still hold highly appreciated securities after a nearly 11-year bull run. By donating the position to a charitable organization, you will receive a tax deduction for the value of your stock contribution as well as eliminate unrealized capital gains taxes.

Keep in mind, it doesn’t have to be an all-or-nothing proposition. Sometimes a combination works best—especially if you want to maintain a toehold in a particular name. Donate the amount supporting your intended cause, diversify the shares needed to secure your core capital, and hold the remaining stake.

Or, if you wish to donate the value of your entire position, but believe your stock will increase in value, you could establish a new, smaller position at the current price after making your donation. This resets the cost basis higher, while transferring what would have been lost to taxes to an otherwise needy cause. The tax deduction on the donated shares will offset the gain on any shares sold, reducing or eliminating your tax costs while achieving a more diversified and less volatile portfolio.

Case Study: The Trifecta

A couple holds a $100,000 position in a pharmaceutical stock that they had bought six years earlier for $15,000. They can avoid the $20,000 in income tax on the $85,000 capital gain* and help their local hospital by donating that $100,000 stock rather than writing a check for the same amount, as they had done in previous years. It would also provide a charitable deduction for the contribution as well as reduce the risk from holding a concentrated stock position (Display). As a result, the effective cost of the $100,000 gift is really just $43,000.

Donor in Top Income-Tax Bracket Chart


The couple was reluctant to part with a stock that had performed so well, but also worried that the sector could be heading for a “winner-take-all” scenario as companies race to find a vaccine. So their advisor reminded them that they could buy a new $30,000 position in the same stock, using the cash they had earmarked for donation to the hospital. The strategy would still fulfill their charitable goal, receive the same charitable income-tax deduction, and reset the cost basis of their position to $30,000.

The Bottom Line

The market’s recent swoon reminds us that concentrating a large percentage of your portfolio in a few names—or even a single industry—can put your prosperity at risk. Diversifying decreases your core capital requirement and significantly reduces your portfolio volatility. When paired with charitable donations, it can achieve the same impact as a cash gift while offering several compelling advantages. Effectively, it allows you to diversify while supporting your preferred charity, reaping the tax benefits, and using the cash to repurchase a favorite security—a win all around.

* This analysis assumes the gain would otherwise be taxed at a long-term capital-gains rate of 23.8%, based on a federal rate of 20% with the 3.8% Medicare surtax. Assumes Florida resident with 0% state income tax.

Daniel Brunello
Director—Wealth Strategies Group
Anne Bucciarelli
National Director—Family Engagement Strategy

The views expressed herein do not constitute, and should not be considered to be, legal or tax advice. The tax rules are complicated, and their impact on a particular individual may differ depending on the individual’s specific circumstances. Please consult with your legal or tax advisor regarding your specific situation.

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