Holding a large concentrated stock position can be an excellent way to build wealth, but it can also expose you to significant risk. If you have a large portion of your portfolio tied up in a single stock, it’s important to think about how this concentration could affect your overall financial strategy. Consulting with your financial advisor can help you make informed decisions about how to manage this risk and fit it into a more diversified wealth plan.

What Is a Concentrated Stock Position?

A concentrated stock position refers to owning a large amount of one stock—typically more than 10% of your total investment portfolio. This situation can arise from various circumstances, such as receiving equity compensation, inheriting a sizable stock position, or holding stock in a company after the sale of a closely held business.

The Risks of Holding a Concentrated Stock Position

Holding a significant amount of one stock introduces higher risk. For example, a well-known blue-chip stock might suddenly face challenges that lead to a sharp decline in value, or a company’s profitability could fluctuate, affecting stock performance. Even broad market movements can impact a concentrated position. Given these risks, it’s important to evaluate your stock concentration early, rather than wait for unfavorable circumstances to force a decision.

5 Ways to Diversify a Concentrated Stock Position

1. Incrementally Selling Shares
   Selling portions of your stock holdings over time can help reduce concentration. This is often the simplest and most straightforward approach. However, it’s essential to consider tax implications, market conditions, and the timing of sales as part of a comprehensive wealth management strategy. If the stock is subject to restrictions, you might also need to file a 10b5-1 plan to outline your selling decisions in advance.
2. Utilizing Net Unrealized Appreciation (NUA)
   If the concentrated stock is in a retirement account, an NUA strategy can allow you to move highly appreciated stock out of the account. You’ll only pay ordinary income tax on the original cost basis, while any gains beyond that will be taxed at long-term capital gains rates when sold. This strategy helps minimize immediate tax liability while still enabling you to take advantage of the appreciation.
3. Hedging the Position with Options
   To mitigate risk, consider using options strategies like purchasing protective put options. These act as a form of insurance against a significant drop in stock value, giving you the right (but not the obligation) to sell your shares at a predetermined price. You could also use a cashless collar strategy, which combines protective puts with sold call options. The income from the call option premiums could offset the cost of purchasing puts. However, these strategies come with additional complexities and tax considerations, so consulting with a tax professional is important.
4. Gifting Stock
   Another strategy for diversifying a concentrated stock position is gifting the shares. This can be a part of an overall estate plan. While gifts are subject to annual tax limits, they can help reduce your estate tax liability. A wealth advisor can assist in determining how gifting strategies can fit into your broader financial and estate planning goals.
5. Donate Stock to a Charitable Trust
   Donating highly appreciated stock to a charitable remainder trust (CRT) offers tax benefits, including a potential tax deduction for the donation. The CRT can sell the stock and reinvest the proceeds without triggering immediate capital gains taxes. This approach allows you to diversify your holdings while also supporting charitable causes, and it can be a valuable part of your estate planning strategy.

Conclusion

Concentrated stock positions can offer substantial rewards, but they also carry risks that could impact your financial future. To minimize these risks, it’s important to consider strategies for diversifying these positions. Whether it’s selling shares incrementally, utilizing tax strategies like NUA, or leveraging options to hedge, there are multiple ways to balance a concentrated position within a diversified portfolio. Work with your wealth advisor to develop a plan that aligns with your financial goals and risk tolerance.