“Don’t put all of your eggs in one basket.” We likely have all heard this old adage at one time or another, but have you ever considered how this very simple saying relates to your investment portfolio as a top-level executive? If not, there’s no better time than today to consider the risks of concentrated stock positions. And, when you work with an experienced executive financial advisor, you can also discuss strategies that are designed and engineered to offset concentrated stock risks. Let’s take a closer look at those risks and correlating strategies.
Risks of Concentrated Stock Positions
The risks associated with concentrated stock might seem basic on the surface level, but many executives fail to take them into consideration as their net worth and concentrated position continues to grow. These risks include:
Future solvency of your employer: How confident are you in the financial well-being of your current employer? This is a hard question to ask yourself as a top-level executive. In theory, your job is to ensure that the company stays financially stable as well as experiences consistent growth year over year. If, however, you have doubts as to whether or not your company will last past the next quarter, you should seriously review your concentrated stock position and implement an allocation plan. Many executives fail to be brutally honest with themselves regarding their employer’s future. This is where an outside perspective from an experienced financial advisor can be very beneficial.
Market volatility: Nearly every executive can relate to the market downturn in 2008 as a learning experience. Hopefully, you were able to fully recover in your personal portfolio as well as your company financials. Regardless, it was likely an eye-opening experience. Needless to say, the market goes through its ups and downs over the years and decades. The question is not if the market will experience volatility as much as when that volatility will happen and how will it affect your concentrated stock position. If you are nearing a transitional time in your life, such as retirement, it is important to reduce your concentrated position to protect yourself from untimely market volatility.
Concentration of wealth: The wealth you have accumulated up to this point in your life was likely benefited greatly by your employee stock options or other forms of equity compensation from your employer. The predicament you likely find yourself in now is that, to preserve your wealth, you need to diversify out of that concentrated position that got you there.
We understand that most large companies will expect or mandate that you hold a certain amount of company stock. The issue begins when your overall wealth is concentrated 20% or more in one stock position, according to most industry professionals. When you reach this point, you risk your overall wealth to fluctuating market conditions as well as the financial solvency of an entity that you aren’t fully in control of.
This might be a scary thought, but luckily there are strategies that can help mitigate some of the risk associated with your concentrated stock position.
Strategies to Offset the Risks of Concentrated Stock
Before implementing any financial strategy, you need to take into account all of the possible solutions for your unique situation. Below are some of the most effective strategies to offset concentrated stock positions:
Asset allocation: When it comes to diversification from a concentrated stock position, utilizing a solid asset allocation strategy is one of the most effective ways to reduce risk in your portfolio. When it comes to allocating the assets you invest in, you must consider factors such as your:
- Risk tolerance
- Age and investment timeframe
- Intent behind the investments
- Income need
- Whether you are focused on capital retention or capital liquidation at this point in your life
In short, asset allocation can help you identify asset classes you invest in and help you bring balance across all of those asset classes using percentage-based models. An experienced executive financial advisor can help you develop an asset allocation strategy that fits your wants and needs.
Exchange funds: An exchange fund is a lesser known, yet highly effective, way to diversify a sizable concentrated stock position. To utilize an exchange fund, it’s important to work with an advisor that is experienced with this type of complex strategy. An exchange fund is designed to accept a large concentrated stock position in exchange for shares of the fund itself, which owns multiple securities. The shares that you receive are equivalent to the current market value of your concentrated stock position, so it is an even exchange and helps relieve your concentrated stock position nearly instantly.
Index proxy: An index proxy strategy is unique in that it utilizes software to achieve the end goal of diversification of your concentrated stock position. Again, as with the exchange fund strategy, this should be executed with the help of an experienced executive financial advisor that has a track record of implementing this type of strategy.
An index proxy takes into account the taxable liability that the sale of low-basis stock can cause as well as the large capital gains that can be achieved by selling appreciated stock. The goal of the index proxy strategy is to slowly sell off the concentrated stock using a complex formula that optimizes taxation along the way. This strategy is one that can be implemented over the course of years or even a decade if the concentrated position is large enough and the investor has the time to do so.
The strategies outlined here today are all very effective ways to offset the risks of concentrated stock positions. A strategy, however, is only as good as the parties involved in implementing it. To ensure long-term success as an investor, it is important to work with experienced advisors who have walked the investment road with countless top-level executives, helping and guiding them along the way.
K. Wade Carpenter, CFP®, AIF®, ChFC®, CLU®, is an innovative wealth manager serving corporate executives and entrepreneurs from coast to coast. Throughout his more than 25-year career, Wade’s focus on C-level clients has made him a top strategist for equity compensation planning and asset allocation. For more information on how Wade and the Carpenter Team can advise you on the risks of concentrated stock positions and strategies to offset them, reach out today for a complimentary consultation.
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