Photo credit: www.kiplinger.com
Over the last 15 years, numerous individuals have shared remarkable stories of serendipity in investing, many of whom have become clients. Consider the woman who transformed her $6,000 investment in Apple stock into a staggering $2.7 million, or the couple who embraced Tesla early on and saw their investment grow to over $10 million. In theory, these individuals are set for life—provided they maintain a diversified portfolio.
However, concentrating wealth in a single stock brings its own set of anxieties. For instance, one investor might fixate on quarterly iPhone sales, while another is consumed with Tesla’s delivery numbers. Despite the enviable position they find themselves in, it prompts a critical question: Will what made them wealthy continue to sustain their wealth?
What Constitutes a Concentrated Position?
To clarify, a “concentrated position” refers to an investment strategy where a significant portion of one’s portfolio—often debated as being 5% to 10% or more—rests in a single stock. This does not typically include a mutual fund or ETF that might exceed a 10% threshold, although some newer concentrated ETFs might fall under this definition.
In our financial planning discussions, we often begin addressing concentrated holdings when they reach 5%, and we become increasingly proactive when allocations exceed 10%. Research from EY highlights a concerning trend: the average lifespan of an S&P 500 company has dropped from 67 years 80 years ago to just 15 years as of 2023. This suggests heightened risks associated with holding concentrated positions.
1. Are You Charitably Inclined and Seeking Income?
For those looking to give back while ensuring income, options like Charitable Remainder Trusts (CRTs) and Charitable Gift Annuities (CGAs) are appealing. By donating an appreciated asset to a charity, individuals can receive a set percentage of income for life in return, providing both a charitable contribution and a potential tax deduction.
CGAs are often used for smaller donations when the donor is comfortable relinquishing control over who receives the remainder at death. For instance, someone wanting to benefit the Michael J. Fox Foundation might prefer a CGA. In contrast, for larger gifts involving multiple beneficiaries, a CRT would be more suitable, allowing flexibility in designating beneficiaries in the future.
2. Not Ready to Sell? Explore Put Options
Separating from a stock that contributed significantly to wealth can be emotionally challenging, especially for individuals who have dedicated their careers to the company. In such cases, purchasing put options can help mitigate potential losses on the stock.
Put options function as insurance for a portfolio; for a premium, they set a predetermined price at which the stock can be sold if its value declines. For instance, owning 100 shares of a stock priced at $100 and buying a put with a $90 floor means that if the stock falls to $80, it can still be sold for $90.
However, options can be costly and may expire worthless if the stock’s price rises. To counteract this, implementing a collar strategy can be advantageous. This involves selling a call option to finance the purchase of a put, thereby creating a range of protected values for the stock—similar to the bumpers used in bowling games.
Investments typically require a certain rate of return to sustain lifestyle needs in retirement; thus, establishing both an upside and downside range is fundamental to a secure financial plan. By employing a collar, investors can protect their financial objectives while navigating stock performance dynamics.
3. Want to Leave a Legacy to Individuals?
For those looking to bequeath a portion of their wealth to family members, careful strategy is advisable. For example, with a portfolio worth $5 million, including $2 million in one stock, designating that stock for grandchildren could prove beneficial from a tax perspective, as substantial capital gains can be avoided through a step-up in basis at death.
However, such a strategy assumes that the successful company today will maintain its value long-term, which is inherently risky given the recent trends noted. In this context, exchange funds offer an intriguing alternative. They allow investors to merge their appreciated assets with those of others, resulting in a diversified portfolio managed by professionals.
After a holding period of seven years, a diversified portfolio of securities is returned while deferring taxes, offering both diversification and tax efficiency.
Each of these strategies entails complexities that necessitate collaboration with financial planners, tax advisors, and legal professionals. The challenge lies in assessing whether the potential benefits justify the complexities involved. If investors find themselves anxious during earnings calls for stocks like Apple or Nvidia, it could indicate a significant stake worth protecting.
* Investing involves risks, including potential loss of principal, and diversification does not guarantee profit or protect against loss. For a comprehensive understanding of these risks, consulting a professional is recommended.
** This article serves educational purposes and is not intended as investment advice or a recommendation.
Related Content
This article reflects the perspective of the contributing adviser and not Kiplinger’s editorial staff. Adviser records can be reviewed with the SEC or FINRA.
Source
www.kiplinger.com