How to Reduce The Risk in Owning Too Much of One Stock & Save Taxes

Having too much of your net worth tied up in one or a couple of individual stocks can be a dangerous game to play. It's one that relies heavily on luck and can present a significant risk to your life savings. Things can either turn out really good or really bad. And sadly, many people often let their emotions and the potential tax ramifications dictate their next move. But should they?

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Welcome everyone to the Retired-ish podcast, where we discuss all things retirement planning, taxes, financial planning, investing, estate planning, Medicare, Social Security, and more. I'm your host, Cameron Valadez, certified financial planner and enrolled agent. Today, we are going to dive into a very common investing conundrum these days that many people fall victim to, and that is, what do I do about all of this money I have accumulated in just 1 or 2 stocks? What if the value of the stock I own gets demolished, and I potentially lose this money that I'm relying on for my life goals or my retirement, let's say?

First, I want to talk about why this can be such a big problem and who this risk pertains to. Then, I'll dive into a couple of strategies you can consider to help minimize this risk.

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This situation commonly happens when you are receiving some sort of stock award or compensation from your employer if they have stock in the company if they're publicly traded, such as stock awarded in your 401(k) plan, restricted stock units, or maybe stock options. Or if you or your spouse happen to get lucky and knock it out of the park with exuberant returns on 1 or 2 stock picks in your individual brokerage account, let's say. This can obviously pose a significant risk to your life plans, and most people can't afford to take that risk.

The issue is that many people who are in these situations tend to actually intensify that risk and continue to accumulate such a concentrated position in 1 or 2 companies. Because they believe that since the investment might have done so well in the past, that it will continue to do so going forward. Or that because the stock they own is a company so large and well-known, there's nothing bad that can happen. And if the value of the stock ever falls, it will eventually come back and more. And I hate to break it to you, but this is not always the case.

To give you some examples, think back for a moment. Remember BlackBerry, which took the world by storm with its revolutionary mobile phones? What about Kodak, at one point the world's leading photography company? Xerox and the machines that nearly every business relied on. What about Enron? At one point, one of the world's largest and most successful companies. The list goes on.

When these companies were at their peak, their investors and employees likely felt the same as you do today about the company you own a significant stake in. The lesson here is that tying up a significant portion of your net worth and your life savings in 1 or 2 companies is a dangerous game and nearly impossible to plan for a reasonable, rational outcome when it comes time for you to start using some of that money for your life goals. In other words, predicting what will happen becomes more of a biased and personal opinion rather than being statistically sound. Not only is there a risk that your 1 or 2 stocks might not perform very well, but you also face the risk of opportunity cost.

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And in general, this essentially means that what if there are other investments that significantly outperform yours in the long run, and you had the opportunity to invest in them. To help put this in perspective, I want to share a quote with you from a gentleman named Hendrik Bessembinder. I think I really screwed that up, but he's a professor of finance at Arizona State University, and he notes that since 1926, most stock market returns in America have come from a tiny fraction of shares or companies. Just five stocks accounted for 10% of all of the wealth created for shareholders between 1926 and 2016. That's nearly 100 years. He continues by saying the top 50 stocks account for 40% of the total and that more than half the 25,000 or so stocks listed in America in the past 90 years proved to be worse investments than Treasury bills, which are like an IOU from the government. Now, these are shocking numbers. What if your particular stock isn't part of the top performers going forward? Worse, what if it performs worse than Treasury bills, which are considered one of the safest and least volatile investments on the planet? To really hammer this home, I want to let you in on a little secret about the mutual fund industry.

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A mutual fund, just as a reminder, is essentially an investment vehicle where you invest your money in a pool of a bunch of other people's money, and you allow a team of investment professionals to pick and choose which individual stocks, bonds, etcetera to invest in hopes of outperforming a particular benchmark, such as the S&P 500, for example. Study after study has shown that the vast majority of these teams of investment professionals and their actively managed mutual funds fail to outperform the respective indices that they aim to outperform.

In layman's terms, this means that the overwhelming majority of people who are highly educated and credentialed in investing and dedicate every second of their workday to analyzing businesses and reading financial statements cannot consistently pick and choose the best companies to invest in any given time frame. Now that we know that, let's circle back. And I know that I may offend some of you here, but hey, this is the reality. This might imply that if you are choosing to continue to accumulate the majority of your wealth in 1 or 2 stocks, especially for those of you with significant amounts in your own employer's stock, you are essentially saying that you have more investment prowess and know-how than these professionals do. Now, I would bet that you really don't. And therein lies the problem.

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We are human. This is what we do. We are overconfident in our own opinions and abilities, and no matter what mistakes or experiences someone else has been through in the past, that would never happen to me. Right? Now, some people have such overconfidence that they take this risk to a whole other level. Not only do they accumulate such a large nest egg in 1 or 2 investments, but they also try to consistently buy and sell the investment and time the markets or economy. As we've discussed in previous episodes, this is a recipe for disaster.
In summary, when doing this, you are ultimately making wild guesses about what might happen in the short term. Not to mention, the markets and the economy are impossible to consistently predict, but people do it anyway every single day.

There are a couple of main issues that frequently happen when trying to time the markets and doing something similar to this. One is that you actually have two decisions to make from the offset, and that is when to sell and when to buy back in. And to be successful, you have to get both of them right. The other issue is that if you sell your investment after the value has capitulated because you want to, let's say, stop the bleeding, so to speak, you may not ever get back in and invest again out of fear and pursue something else entirely, which can potentially cause a permanent loss of money.

In other words, it only takes one single mistake in all of about 3 minutes to ruin a lifetime of savings and investment returns. The best thing you can do if you find yourself caught in this investment behavior is to ask yourself, should I really be doing this? What level of risk am I subjecting myself to? How much money do I actually need for my goals? And better yet, would I feel worse losing a significant portion of this money or simply not making as much as I had once thought over the long run? And I love that last question because studies show that investors tend to have a harder time losing money than they do making money, which makes sense. Okay. So now that we've beaten that over the head, let's talk about how you can begin to mitigate this risk of overconcentration and how to do it in a tax-efficient manner.

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The most simplistic way to avoid the risk of overconcentration in 1 or 2 stocks, or any investment for that matter, is to diversify. Now, diversification is the concept of not putting all of your eggs in one basket. You've likely heard that before. You can diversify amongst different types of assets such as real estate, stocks, gold, bonds, cash, etcetera. But in order to stay on the topic of stock markets, one way to to diversify within the stock market would be to own many more stocks than just 1 or 2. It sounds kind of intuitive. Right? That way, if something happens, something negative in the short or the long term with those companies, you may have others that don't perform as badly or perform positively. Diversification is widely known by investing professionals to be the only “free lunch” in investing.

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The purpose of diversification is essentially to increase the probability of receiving the return on your money needed to try and reach your specific goals. Typically, the less diversification you have, the higher the probability you might exceed the return that you need, but at the same time, the higher the probability that you may fall well short of the return needed. That being said, in order to diversify yourself more, you will want to consider implementing some sort of plan to sell or divest some or all of the shares you own in the particular company over time. Most importantly, the plan you make needs to be one that you agree with and will continue to implement during good times and bad. Now, I want to take a second to caveat that sometimes you may not be able to implement some of these strategies that I'm gonna go over right away given your particular circumstances. If you have highly appreciated stock positions in your own brokerage account or retirement account, it's a little more straightforward. But if you're receiving stock awards from your employer, there are usually restrictions on the timing of when you can exercise things like stock options and buy or sell. So, in the context of this episode, let's assume you already have full autonomy and control over when you buy or sell your stock.

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For example, and I'm not saying I would necessarily do this, but this is just an example. If you were to already have a large portion of your net worth tied up in your company's stock, you might make a plan to sell any new stock awards or compensation that you accumulate going forward and reinvest the proceeds in another investment. Over time, this will start to diversify you. But depending on the size of your future stock awards, it might take quite a bit of time to get sufficiently diversified when it comes to your entire net worth. Another example might be that anytime you have a particular set of shares increase by a certain percentage from the date you receive them, you sell those shares and reinvest the proceeds in another investment. This can encourage good investing behavior by selling high and buying low, which few investors actually do. However, if the shares don't appreciate ever, you might be caught in a bit of a conundrum. You can get as granular as you want with this.

Some might take a more basic approach and try to diversify more quickly by saying, hey. I'm gonna sell 1% of my shares each month and reinvest that money in something else. This would mean 12% a year, and in a little over eight years, you would be completely out of the stock position, assuming you weren't also continuing to add to it with, you know, a new position or new stock compensation. If you were to do this inside an account like an IRA, Roth IRA, or 401(k), you wouldn't really have any tax ramifications while actually doing it. Now if you own stock in a brokerage account or, let's say, a trust account or something like that, that has a lot of taxable gains. So things get a little more interesting. You'll want to get a little more creative. The reason for this is because if you start selling your investment, you will begin to trigger taxable gains in the years you sell.

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This could potentially cause a ginormous mess with your taxes and even cause you to pay other additional taxes you didn't even know about. And, oftentimes, due to the issue of taxes alone, people with concentrated stock positions won't do anything or diversify simply because they are fearful of the tax ramifications. So they'd rather subject their life's work to such a tremendous risk in the market rather than pay taxes. And, hey, I get it, but there are better ways to go about it. So, I just want to throw this out there. Utilizing a professional adviser in these situations is highly recommended.

Okay. So, when it comes to diversifying our position, we want two things. We have two goals, so to speak. One is we want to diversify and mitigate the big risk of having too much of our life savings reliant on 1 or 2 companies' success. And two, we want to pay as little in taxes as possible on our gains.

I want to mention two other very important thoughts on this. In my opinion, if enough of your overall net worth is in 1 or 2 concentrated stock positions, diversifying is more important than the tax ramifications. And I wouldn't let those tax ramifications stop me from diversifying. The second thing is that when it comes to doing this in a tax-efficient manner, there are a lot of different ways you can do so. But I am only gonna go over one as it pertains to my previous example. So, if you want to know the different ways as they pertain to your situation, I would suggest reaching out again to a professional.

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You can also call my firm, Planable Wealth, or reach out to us in the episode show notes to book a 15-minute discovery call with our team. Okay. So, back to our previous example, where you might consider selling 1% per month or 12% a year to start diversifying. Now, this could be any percentage you choose, but for now, I'm sticking with my 12% example. So, instead of selling 1% each month, you may consider selling the entire 12% quickly at the beginning of the year. In doing this, in my example, you would have a taxable gain because you have this highly concentrated stock position that has grown tremendously over time. Most of it has taxable gains. So you would have a taxable gain, ideally, when you sell, but you will know what that gain is after you sell it right at the beginning of the year.

Then, you can take the proceeds and reinvest them in a broader basket of stocks, for example, using maybe a mutual fund, an index fund or an ETF, for example. The overall US stock market, on average, experiences a 14% decline during any given year. Some years, it goes down a lot more, some, it goes down a lot less. And again, what I am saying is that at some point during the year, the market typically has a sizable decline. It's actually very normal behavior. This is often the case even if the market ends the year positive, let's say, 20%. Because of this, what you might consider is eventually selling the investment you just bought into after one of those declines in order to lock in a loss for tax purposes. This can help offset some of the taxable gains you recognized early in the year when you sold part of your concentrated stock position.

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However, the next step is equally important, and that is you will want to reinvest the money again after you sell it for a loss in another diversified investment vehicle. But you have to be careful of what is called the wash sale rules. Essentially, you cannot reinvest the money into something substantially similar and still take the the loss for tax purposes. Now the goal of this strategy is to diversify, mitigate taxable gains in the given year by doing what's called tax loss harvesting, and third, to stay invested. It's a 3-parter.

So, as you can see, because of some of these unique rules in being able to have an expectation of what your tax picture will look like is why I would recommend getting a professional involved.

So, let me just recap this process one more time. At the beginning of the year, you sell your concentrated stock position, and you purposely recognize a taxable gain. Then you take the proceeds from that sale, and you reinvest them in some other diversified investment. Now, that investment will either go up or down throughout the year, but at some point during the year, on average, we have a big decline. So if the value of that second investment declines substantially, you can sell it, take that loss, and then take those proceeds, and immediately reinvest them back in the market into something that is not substantially similar to whatever investment you just owned. So that allows you to take that loss, and that will offset the gain you recognized at the beginning of the year, and you're still invested in the market. So it's not like you're timing the market, and your money is now sitting on the sideline in cash.

You can also do a similar strategy by possibly investing extra cash that you may have in the bank into the broader market and then selling that investment once the market turns down. And depending on how much you invest, you may be able to offset more taxable gains, gains that you would have from selling your concentrated stock position. This strategy, however, would entail that you invest more money than you already have in the markets, which may or may not be the right thing for your situation.

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Just know it's an option if you had other money that eventually you were going to invest and it's currently sitting on the sidelines. Now, if instead you sold 1% per month and didn't do any tax loss harvesting with your other investments, you wouldn't have any tax losses to help offset the gains you incurred during the year. Also, you would need to stay on top of this. If you decide to wait until the end of the year to implement this strategy, you might have missed the more opportune time throughout the year to realize any potential loss. So if markets come back up by the end of the year and now you want to do something about it, well, it might be too late. There might be nothing to do, and now you're stuck with those taxable gains for that year.

Now, I want to be very clear that this strategy is not magically making taxes disappear. What it does is allow you to start diversifying in a meaningful way and kicking the tax can down the road. This can be beneficial in many ways. If, say, you retire and have no immediate income sources, you can begin to sell some of your investments and possibly stay in the 15% federal tax bracket and maybe even pay no taxes on the federal level at all. Now, this ultimately depends on your situation at the time, but all of these strategies together can be incredibly powerful.

If, instead, you don't do anything and you wait until you need to spend the money to make these decisions, oftentimes it will be too late, and you will have foregone potentially tens, if not hundreds, of thousands of dollars in savings. And lastly, I want to mention that for those of you with employer stock in your 401(k) plan specifically, there is a little-known strategy called net unrealized appreciation, or NUA for short, that, if done properly, could potentially save a lot of money in taxes. I will save NUA for a future episode, but if that sounds like your situation and you'd like to learn more, reach out to our firm, Planable Wealth, for a discovery call.

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Hopefully this helps. If you know someone in a situation like this, please share the episode and help them out. And if you find the information and strategies I provide on this show actionable, valuable, and insightful, please subscribe to or follow the show on your podcast app. While you're at it, do yourself a favor and sign up for the Retired-ish newsletter as well to get more useful and easy-to-digest information on retirement planning, investments, and taxes once a month straight to your inbox, no spam.

Of course, if you want to learn more about the topics I went over in today's show, or you want to connect with us to see how you can implement a plan of attack for your highly concentrated stock positions, you can find links to the resources we have provided in the show notes right there on your podcast app, or you can just visit us at retiredishpodcast.com/51. Thanks again for tuning in and following along. See you next time on Retired-ish.

Disclaimer [00:23:51]:

Securities and advisory services offered through LPL Financial, a registered investment advisor, Member FINRA/SIPC.

Tax and Accounting related services offered through Plan-It Business Services DBA Planable Wealth. Plan-It Business Services is a separate legal entity and not affiliated with LPL Financial. LPL Financial does not offer tax advice or tax and accounting related services.

The opinions voiced in this podcast are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which strategies or investments may be suitable for you, consult the appropriate qualified professional prior to making a decision.

The S&P 500 is a stock market index tracking the stock performance of 500 of the largest companies listed on stock exchanges in the United States. Indexes are unmanaged and cannot be invested in directly.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

Government bonds are guaranteed by the US government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value.

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.

Neither LPL Financial nor its registered representatives offer tax or legal advice. Always consult a qualified tax advisor for information as to how taxes may affect your particular situation.