Even billionaires are concerned about financial planning, if their recent stock sales are any indication.
Last year, Elon Musk, Mark Zuckerberg and Jeff Bezos were among the uber-wealthy tech founders who cashed out significant stock positions. According to the Bloomberg Billionaires Index, some of the wealthiest Americans took profits that totaled nearly $43 billion last year.
Of course, no one but those who are selling can say for sure, but looming tax increases may be a factor behind these transactions. While the tax considerations for billionaires are vastly different from those who are not billionaires, financial advisors say anyone holding single stocks should review their portfolios and be prepared to make some tough decisions, especially after a strong rally in stocks.
With major indexes hitting fresh highs in 2021, many retirement investors are now sitting on hefty capital gains in equity positions held in taxable accounts. That’s especially true for those who have owned stocks or stock funds for many years and have a low cost basis.
In addition to possible capital gains tax hits, investors face diversification problems if individual stock positions are highly concentrated or constitute too great a proportion of their total holdings.
Sometimes, investors hold single stocks because they bought them or inherited them years ago and never sold. Others own particular stocks just because they like the company and want to own the stock. Employees at companies that offer stock options may also find themselves with high concentrations of company shares.
Offsetting Gains With Losses
Tax-loss harvesting is one solution for paring back those high concentrations or cleaning up a portfolio with too many single stocks. That is the process of selling securities at a loss to offset capital gains when selling other securities. However, with stocks performing so well for so many years now, it’s often challenging to find equities to sell at a loss.
Jason Escamilla is CEO at ImpactAdvisor in San Francisco, where many investors have tech company options. He says a large percentage of the firm’s clients hold individual stocks. Balancing the tax hit against diversification may involve more than simple tax-loss harvesting, he says.
“At some point, portfolios run out of losses to harvest with basic tax-loss harvesting strategies. This is especially true when the portfolio consists of broad-based funds,” he says.
In some client accounts, Escamilla’s firm employs what he terms “strategic gain realization.” That could mean turning to vehicles such as donor-advised funds, charitable trusts and qualified opportunity zone funds.
Matt Wollman, vice president of investments at Wedbush Securities in Los Angeles, says his firm talks to clients about single-stock risk.
In addition to suggesting tax-loss harvesting and donor-advised funds, options Wollman discusses with clients include:
— Use of exchange or swap funds. These allow investors to substitute a concentrated position in a stock with diversified units of stocks valued at the same price. This serves two purposes. It mitigates portfolio risk and defers tax consequences. Wollman says a caveat is that the exchange fund must accept the investor’s holdings. “Larger company stock is often accepted,” he says. “Smaller is on a case-by-case basis.”
— Donating stock to charity directly. Investors can take a deduction for the full donation amount, up to 30% of their adjusted gross income.
— Creating a charitable gift annuity. These vehicles allow the account owner to make a charitable donation while getting a partial tax deduction and a lifetime income stream for a beneficiary.
— Gifting stock to family members. An individual can gift $15,000 to an adult child without filing a gift tax return in 2021. A married couple can gift a total of $30,000 to an adult child.
Besides tax quandaries, concentrations in single stocks can wreak havoc on financial plans.
Calculating Single-Stock Risk
It’s certainly possible to calculate the expected return of a single stock using risk analysis or backtesting software, and single-stock risk can be incorporated into a financial plan. Those calculations typically show that individual stocks add portfolio risk. That could make it more difficult to achieve a successful financial outcome.
Jay Zigmont, founder at Live, Learn, Plan in Water Valley, Mississippi, says it’s important to consider the source and thought process behind a high allocation in a single stock.
He commonly sees clients with a concentration in their employer’s stock, either through options or employee stock purchase plans. In these cases, he says, clients have extended risk, as they own a large stock position from the same source as their primary income.
“Additionally, they may have plan restrictions on the sale of the stock,” Zigmont says. “With these clients, I work hard to help them to understand the risks and develop a plan that reflects both the tax and investing implications.”
He notes that diversifying holdings is not necessarily a fast process. “There are times where we need to work through the emotional connection to the stock before we can get to the tax and investing implications,” he says.
Have a Plan for Single Stocks
Georgia Bruggeman, founder and CEO of Meridian Financial Advisors in Holliston, Massachusetts, says clients with concentrated stock positions should have a plan for those holdings.
For example, just because a client wants to own a particular stock, the plan may show that a smaller position is preferable to the current holding.
“Always consider offsetting gains with losses if you have any,” Bruggeman says. “But be careful here, too. If the loss is modest and short term, you may be putting the tax tail before the investing dog.”
She adds that many clients simply want to hold individual positions they have owned for years. “This is fine if it fits with the overall recommended allocation,” Bruggeman says. However, investors must review their holdings carefully to be sure there is not an unintentional overweighting in a particular asset class.
“Maybe some positions have to be trimmed. Maybe they are top-heavy in large growth but have no small cap or international,” she says, adding that investors should develop a plan to reduce these heavily weighted single-stock positions.
Bruggeman adds that proceeds from stock sales, if not gifted using the gift tax exemption, should be used to improve portfolio diversification, “preferably with some low-cost passive ETFs to offset the single-stock risk.”
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Learn From Billionaires: Investors Should Consider Selling Stock Positions originally appeared on usnews.com
