But our executive also owns company stock worth $100,000 in her firm's ESPP and another $100,000 in stock in her 401(k). Therefore, her equity in company stock totals $500,000 but she controls a total of $1.2 million. Assuming the cumulative value of her total portfolio is about $2 million, she has more than 50% of her portfolio assets tied up in a single stock in various places. She likely has no idea she is this highly concentrated and vulnerable.
When this is clarified, it can help you support the argument that she should gradually unwind her position. She should retain the upside potential provided by her options and that's a sufficient concentration of company stock. To protect herself on the downside, we would recommend she diversify out of the remaining stock. We use sophisticated aggregation software to demonstrate the potential impact of the concentration. It's a great tool to help clients see the total picture more clearly so that they can embrace diversification and control their risk.
Regardless of other issues, when heavily appreciated stock is involved, the tax ramifications are almost always a concern.
For some clients, liquidating large stock positions requires a discipline such as dollar cost averaging, where we agree to sell off a small portion of the holding each month, perhaps 5%, until it is liquidated.
Where's The Value?
It's easier to help clients rebalance when you avoid dogmatic adherence to traditional asset allocation when performing portfolio value analysis. Sometimes, we can exchange appreciated issues for something that appears to be undervalued in a 3, 4 or 5 to 1 ratio that increases the number of shares held, and hence, the opportunities for future appreciation.
You can also avoid investment pigeonholing and instead compare diverse asset classes with one another. For example, some years back, a popular technology company's stock was trading at 95 times earnings with no dividend. The building it was in, however, was selling at just eight times earnings and offered a 10% cash dividend. Tech stocks were hot; real estate was not. It would have taken ten years of stock earnings to equal one year of earnings on the real estate dividends. I thought that represented a relative bargain, and so we sold some of the stock and bought some of the real estate.
As of this writing, real estate stocks are down significantly from their highs of a few years ago. Government bonds are currently paying about 3%. But you can get 8%-10% cash flow out of some of the buildings where government is housed. So there are some attractive mispricings in the depressed real estate market. Of course, getting clients to embrace this for their own portfolio can be a tough sell, but investor perception and resistance is what helps create market inefficiencies. This relative value proposition can help motivate clients to diversify by selling off highly appreciated stock and using the money to buy something that appears underpriced.
Clients create wealth with concentrated bets and keep wealth through diversification. As trusted financial advisors, it's our role to help clients do what is best for them: which is to avoid overconcentration of core money intended to fulfill their financial plan and their goals. For recalcitrant clients, the trauma of selling off an overgrown position may be akin to cutting off a finger. For advisors, it can be a valuable lesson in behavioral finance.
Whatever surgical procedure is chosen, whether it is the use of dollar cost averaging, OTM calls, the substitution of an unpopular asset class, or simply the use of limits and stop orders, it's vital that we help ease decisions for our clients so they can rebalance, pay the tax and move on. Helping clients overcome the emotional attachments and blocks associated with oversized individual stock holdings is one of our great challenges as advisors.
Andrew Dodds, CFP, is principal of Dodds Wealth Management Group, Englewood, Colo. He is a registered principal with and offers securities through LPL Financial, member FINRA/SIPC. He can be reached at (303) 539-3900 or [email protected].