All of your wealth in one stock—are you at risk?

 Kaylin Klinger, Wealth Strategist

Few people set out to concentrate their wealth in a single company. Yet, over time—whether through career choice, investment selection or inheritance—many find themselves holding significant wealth in a single stock.

If you fall into this camp, you may be wondering if the inherent risks of maintaining the position outweigh the potential rewards—an especially complicated consideration for public company insiders who must comply with company and regulatory policies.

Assessing your position’s exposure to three key risk areas can help you decide if action is needed. The relevant solutions provided below can help bring you closer to your financial and personal goals.

1. The risk of losing money

As with any investment, what goes up can just as quickly go down. The risk to your personal balance sheet can be amplified if a single event or bad quarter significantly impacts the individual company whose stock you own. To regain control:

Determine how much of your portfolio to insulate from single-stock risk (Investors and insiders)

Analyze your full financial picture to determine how much diversification you need to accomplish your long-term financial objectives. You likely will fall into one of two camps: 

• Protected—You could lose your entire concentrated position tomorrow and still achieve all your goals
• Vulnerable—You need to retain a portion of the concentration to reach your goals

Understanding how much of your concentrated position you eventually need to diversify will empower you.

Sell, but avoid moving the market with block trades (Insiders, proceed with caution)

Block sales enable you to sell a large number of shares in a single transaction at a negotiated price. This removes the risk of the stock price dropping as you try to sell, which can happen if you’re divesting a significant volume of shares.

If you are an insider: Be sure you have the blessing of your company’s general counsel and execute the sale in an open-window period.

Limit your exposure with collars (Not for insiders)

If you worry about the downside risk of your single-stock position but have faith in its potential, implementing a collar-like strategy may provide protection that’s also cost efficient: This structure limits your downside exposure to a predetermined amount (for example, to a stock price decline of 10%)—and limits your potential gains, offsetting the cost of this protection.

Some investors use a collar to secure a loan—with the position as the collateral—and invest the loan proceeds in a more diversified portfolio. They hold the portfolio until they want to trim their concentrated position.

While many executives are restricted from employing covered calls, collars or similar hedging strategies, they may turn to them after they retire to manage their single stock concentration.

2. The risk of taxes

By the time you decide to take some of your concentration off the table, your shares will likely have appreciated substantially, creating a significant tax liability if sold. Here are some ways to maximize the after-tax value of a single-stock position:

Prefund your philanthropic giving with a Donor Advised Fund (DAF) (Investors and insiders)

If you regularly give to charitable organizations: Consider contributing low-basis, long-term appreciated stock to a Donor Advised Fund in a particularly high-income year.

When the shares are sold within the DAF and the proceeds are reallocated to a diversified portfolio the benefit to you is threefold: 

1.  You will not incur capital gains tax.
2.  You will be entitled to an immediate charitable deduction that will enable you to align the deduction to the year that most benefits you.
3.  You have the flexibility to decide when to distribute DAF funds to charities of your choice over time.   

Note: All funds in a DAF must be contributed to charity.  

Diversify your position and create an income stream with a Charitable Remainder Trust (CRT) (Investors and insiders)

With a CRT, you transfer shares into an irrevocable trust for the trustee to sell and reinvest the proceeds in a diversified portfolio.

Similar to a DAF, you will not incur capital gains taxes and may deduct the fair market value of the charitable component in the year of contribution.¹ Unlike a DAF, which entirely benefits charity, a CRT generates significant cash flow to you in the form of an annual income stream that is taxable to you upon receipt.

The remaining assets are distributed to charity when the CRT ends, whether at the end of a fixed term (up to 20 years) or upon the death of you or your spouse if created as a lifetime or survivor CRT.

Create a diversified portfolio without an immediate tax bill with an exchange fund (Not for insiders)

With this strategy, you contribute your single stock to an exchange fund and in return receive units of the fund. These units maintain your original cost basis.

Because each investor in the fund contributes shares of different companies, the units you receive represent a diversified basket of securities. The exchange is not deemed a taxable event, provided you wait seven years to redeem your units. During this period, you hold a diversified portfolio of assets and delay your tax bill.

3. The risk of negative public perception

As any current or former public company executive knows, the restrictions of being a company insider add another layer of risk to managing a single stock position. As an insider, all transactions in company stock are reportable and often scrutinized.

Therefore, it is imperative that you comply with all insider sale restrictions imposed by your company and strive to avoid surprising financial markets.

Here are ways to protect yourself from unwanted scrutiny:

Sell your company shares via a 10(b)5-1 plan (Insiders)

A 10(b)5-1 trading plan can protect you against accusations of trading on material nonpublic information (MNPI) and reassure public markets. This type of plan:

• Must be established during an open-window period when you are not in possession of MNPI
• Outlines which shares you would like to sell in the future at specified prices
• Goes into effect after a cooling-off period has taken place

Train the market to expect a sale (Insiders)

Financial markets like predictability. As a result, many insiders help the market know what to expect by either selling annually as soon as their equity awards vest, or through a 10(b)5-1 plan. Consistency is key and reduces the risk of signaling that there may be issues of concern within the company.

We can help

Concentrated stock positions are often responsible for significant wealth creation. They also can be the cause of meaningful wealth destruction.

What role can your concentrated position play in fulfilling goals you have for yourself, your family and your community? Your answer will help guide you toward taking advantage of opportunities and navigating the risks unique to concentrated positions. 

This article is the third in a three-part series that looks at concentrated positions—and the unique opportunities they afford—with a goals-based perspective.  (Read the first two articles: Worried you may own too much of one stock? and Make the most of your company stock, today and tomorrow)

Your J.P. Morgan team is ready to assist you in (re)evaluating your single-stock position and how various strategies can move you closer to your goals. 

¹The charitable component of the CRT is the value of the charitable remainder interest which is calculated as the value of the donated property less the present value of the annual income stream that you will receive.