The continuous market volatility reminds us about the importance of portfolio diversification. It is one of the fundamental rules of investing not to sell when stock markets are down. At the same time, it is an excellent time to think about concentration of company stock and actions one should take when the time is right.
Owning a substantial number of shares and stock options in your company creates a dilemma. Doing so can help you accumulate significant wealth if the stock price rises. At the same time, however, the risk of being overly concentrated can cause your net worth to plummet quickly if the stock price suffers a nosedive.
So what should you do—sell and diversify or hold on? That is a question I get asked a lot.
The answer depends on various factors and is different for everyone, depending on your financial and life goals, how you earmark assets for immediate and long-term goals, your risk tolerance, how much wealth you have built, and how diversified your portfolio is.
There is no defined rule for what constitutes over-concentration and experts have varying opinions. In my opinion, concentration occurs when company stock (or any single stock) makes up anywhere between 10% to 25% of your net worth.
It is easy to find yourself with a concentrated stock position if you work at a company for a long time and you receive various stock grants and options. If you are an executive or part of the initial founding team, concentration levels can be more than 90%. This is especially true if you are unable or reluctant to sell the stock.
There can be good reasons to continue holding company stock, such as being bullish and expecting future stock price appreciation. Or you may have a strong emotional attachment to the stock due to being a current or past employee of the company or owning the stock through an inheritance from a loved one.
Securities laws, such as lock-up periods and 10b5-1 trading plans, can prevent you from selling the stock, even if you want to. Estate planning considerations, such as the ability to gift highly appreciated stock at death and take advantage of a step-up in tax-cost basis, are another reason some people hold onto concentrated positions.
Putting aside these reasons and considering your own personal and family wealth, how and when do you diversify?
I advise my clients to focus on fulfilling your life and financial planning goals while also accumulating wealth at the same time. The first step is to take inventory of your assets, including company stock, stock options, and real estate. Treat your net employment income as an asset for purposes of this exercise. Afterall, your ability to fund future goals will mainly depend on the income you earn from continuous employment.
You should also assess your liabilities, such as your mortgages for your primary residence and any other real estate holdings, other debts, and future college funding needs. The assets you own will allow you to cover your liabilities and living expenses and at the same time fund financial planning goals. They will also allow you to build discretionary wealth—wealth that you can use to pursue charitable giving or other goals.
Once you know and understand what you need to earmark to cover your core goals and liabilities, you can then determine what percentage of your concentrated stock to sell. Concentration will have a different meaning once you are able to sell and diversify the portion of your company stock that is earmarked to cover specific liabilities and financial goals. Beyond that is what we consider to be discretionary wealth.
This approach to diversifying out of concentrated stock can give you peace of mind, even when you believe the stock hasn’t reached its full potential. Creating your strategy to diversify on values-based decisions will make the diversification process easier.
Note that there are tax consequences when you sell and diversify out of concentrated stock positions, so be sure to consult a tax advisor before making any decisions.
Founder, Freedom Trail Financial
Beata Dragovics is the founder of Freedom Trail Financial, an independent wealth management firm. Freedom Trail Financial works with biotech, pharma and tech professionals, families, and women.
Beata works with clients to develop comprehensive and customized financial planning, investment management, and equity compensation solutions that are tailored to help achieve professional, financial, and personal goals. The firm specializes in helping clients with equity compensation strategies to maximize their company stock and option holdings as part of their extensive and holistic plan.
As the principal and a financial advisor at Freedom Trail Financial, Beata is a continuous resource to her clients in times of change. She helps clients think differently about their future, clarify their goals, and see how financial planning can be in alignment with their personal values and lives.
Beata is a CERTIFIED FINANCIAL PLANNER™ practitioner and earned her bachelor’s degree in business management from the Budapest Business School and her master’s degree in financial planning from the College for Financial Planning. She holds the FINRA Series 7 and 66 securities registrations.