With the market indices becoming increasingly top-heavy due to the run up of a select few tech names, it is not uncommon for us to get questions like this: “Help! I have 10% of my portfolio in XYZ stock! What do I do?” In this month’s newsletter we are going to cover how to handle concentrated positions in your portfolio.
Gradual unwind
The most common method for handling portfolio concentration is gradually winding down the position. You may be able to use tax loss harvesting, a strategy in which you net a gain in certain shares of the concentrated stock against a loss held on other shares. For this to be effective, the trades would have to be made within the same tax year.
Sell the position
We wouldn’t recommend this strategy without careful consideration, but we have heard of folks taking the entire gain in one year, and paying the tax all in one year. This might make sense if you have a large capital loss you are expecting to recognize, or if you are going to be in a low tax bracket for reasons such as lower-than-normal income or significant charitable giving deductions.
Gift the shares
If you have a large capital gain on your shares, you may gift them to a charity in order to be relieved from capital gains tax. Many custodians offer Donor Advised Funds, which allow you to submit the shares to a third party vehicle. They are held in your name on an irrevocable basis (meaning that you give up ownership of them). The shares are then liquidated and managed in accordance with your instructions, until you opt to grant the proceeds (or part of it) to a charity.
Wait and see
You may choose to retain the position as it is, and monitor over time. It’s possible that the capital gain may be reduced by market declines. If you keep the shares until you pass, the cost basis may be stepped up to the market value at the time of your passing, essentially eliminating the gain.
Trailing stop loss orders
A stop loss order is a trade order that specifies the price at which the shares are to be sold. This is a way to protect your position from downside risk. If the market dives and the shares drop, the order is executed at the specified price, conceivably “stopping” the loss from growing.
A trailing stop loss order automatically moves up as the price of the stock increases. It is set as a percentage of the asset’s price. This avoids the need to constantly adjust the order as prices change.
Sell limit orders
This type of trading order dictates that a stock be automatically sold at a certain price or higher. These orders can be used if you wish to sell off a position without having to monitor the market. You can set the limit orders on certain shares if you wish to sell off parts of the position at a time, to realize capital gains tax gradually.
Options-based hedging strategies
This is a more sophisticated technique that involves the use of options, or contracts whose value depends on the value of the underlying asset. Options provide you with the right but not the obligation to execute a trade at a certain price. You either pay or receive a fee for the contract, depending if you are the buyer or the seller, respectively.
The most common types of option strategies used to hedge a concentrated position include protective puts, covered calls, and collars.
- A protective put involves buying a put option, or the right to sell a stock at a certain price. This protects you from losing money if price of a stock you own goes down. You pay a premium to buy the contract.
- A covered call involves selling a call option, or giving someone else the right to buy a stock from you at a certain price. Because you are selling an option, you make premium income. If the shares stay low enough, the contract won’t be exercised. However, if the shares rise in value above a certain price (the strike price), the buyer will likely exercise the call option and you will deliver the shares for a lower price than what prevails in the market.
- A cashless collar involves buying a protective put and a covered call contract simultaneously. The idea is that the premium income from selling the call offsets the cost of buying the put.
In these scenarios, the contracts would be written on the same underlying stock as the shares you hold in concentration in your portfolio. Options hedging can be complicated; please consult with a financial professional if you wish to move forward with such a strategy.
Got a concentrated position?
It’s important to note that this advice is general in nature and nothing may be interpreted as a recommendation specific to any one individual. We are not CPAs or tax advisors. As such, please consult with your tax or financial advisor for recommendations that apply to your personal situation.
If you’d like to meet with us, please reach out to set up a time.