A commonly accepted guideline in the financial planning world is that no one “holding”, or “position” should represent more than 10% of one’s overall portfolio (total assets). In other words, if you own $1,000,000 in assets, you shouldn’t own more than $100,000 of any one stock, mutual fund, etc. If you own more than 10%, we call that a “concentrated position.” If you have a concentrated position, you need to make some conscious decisions about whether to keep it or unload it. If you decide to unload it, here’s how to do that in the smartest way.
When we say a “holding” or “position,” we are referring to an asset. It could be anything — stock, bond, crypto, home equity, options, etc. Having any one holding that exceeds 10% of one portfolio is considered a bad idea because if that holding becomes worthless, the impact on the overall portfolio is greater. Some planners use a 5% guideline, depending on the overall portfolio composition.
Think about it, if you have $1,000,000 and $500,000 of that is in one company stock that loses 90% of its value, your portfolio is now worth $550,000, a loss of 45% of the value of that portfolio. If that company is now on the chopping block, its stock may never recover from those losses, and you have to find a way to get your portfolio growing again.
That’s not good for you. Not only do you feel sick to your stomach, but whatever dreams were attached to that $1,000,000 are now vulnerable. College funding? Retirement? Travel? Buying a home? Sabbatical? Starting a business? All those dreams now have to be re-evaluated. Do you put them on hold? Eliminate them all together? Do them anyway but risk depleting all your assets? These are not fun choices.
So how do you avoid this scenario?
Sell and diversify your concentrated position.
Let’s Do The Math
First, figure out if you have a concentrated stock position. List your assets and their values. Add up those values for a total. Take the value of each asset in that list and divide it by the total value. That’s the percentage of your portfolio it represents.
Example: All assets equal $1,000,000. AAPL stock is worth $350,000. $350,000 divided by $1,000,000 is 35%. 35% is greater than 10%. That’s a concentrated position.
Commit To Selling
Truly, this is the hardest part and usually results in whining, pity parties, and procrastination. I have heard it all. Yes, I know you love the stock, the crypto, or whatever it is. I know you feel like a genius for having bought so low and made so much money. I know you are attached to it and feel like it is going to solve all your future financial desires and/or problems. I know you don’t want to pay capital gains taxes. I know you think that nothing else could possibly appreciate as much as this asset has. I know you think the value will double or the stock will split. I know that you know someone who paid for their retirement with only one stock. I know, I know, I know.
The prudent action is to sell and diversify that money into other assets. I know it feels painful, and I know it might go against what your “gut” is telling you about the future of that stock. People get so upset about paying taxes, but paying taxes means you made money and you get to contribute to the greater community through taxes. That’s a good thing. Don’t let the tax tail wag the dog. Come up with a plan to reduce your holdings, reinvest elsewhere and methodically execute it.
Your Options For Selling
There are many strategies for unloading the asset, and these are worth exploring with your advisors – financial, tax, estate planning – because your situation is unique. Maybe the asset can be sold over time to manage the capital gains taxes. Maybe a Deferred Sales Trust might be an option for you. A seasoned trader can make money in options trading on your stock while you slowly divest. Maybe you should donate the asset.
As a side note: You should also figure out what you will invest in. You might find that you’re excited about that opportunity, which makes the selling of this asset start to feel like a genius move, even if it was to start.
Sometimes I will let clients keep their concentrated positions. Here are some of those exceptions:
- Home equity. So many people have a ton of home equity, which frequently represents 40% or more of their overall assets. Selling and relocating a primary residence is often not preferable nor sensical for a variety of reasons. They keep the house.
- Impending death. While there is still a step-up-in-basis at death rule, clients are best off owning highly appreciated assets when they die because the beneficiaries can sell those assets the next day with little to no capital gains taxes. If grandma has less than a year to live, it might be worth letting her keep the asset.
- No/Low impact. If clients have gobs of money elsewhere such that if the concentrated position would have no or low impact on the clients’ financial goals and dreams, should it become worthless, they can keep the position. For instance, clients who have purchased cryptocurrency or tech stocks for pennies in their “fun money” account that we don’t include in their financial planning. They can do whatever they want in that account.
- Donations. Similar to the above, if the asset is not key to the clients’ financial well-being and is intended to be donated to charity (direct donation, donor-advised fund, etc.), that assets should not be sold but transferred “in-kind” – that is, the actual stock certificates should be transferred to the entity, not the cash from the sale. Let the charity do the selling.
The Bottom Line
The prudent path is to watch your portfolio and make no asset becomes too large of a portion of that portfolio, and when they do, take action to get it rebalanced.
About the Author:
Jessica Lanning JD, CFP® brings focus and perspective to your individual financial needs to identify your opportunities for investment and wealth. Regardless of what you’ve done before or what “mistakes” you think you’ve made, Jessica can help get you back on track quickly and safely. As a former practicing lawyer, she brings a comprehensive approach to legal, tax, and financial challenges so that her clients can enjoy peace of mind. A huge proponent of conscious decision-making, Jessica makes sure her clients are educated and informed so that they make sound decisions with clarity and confidence.
Lanning Financial Inc. is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.