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  • Single stock diversification advice

    Hello everyone.  First off, the obvious: I have truly appreciated and benefited from the collective wisdom contained on this blog.  Thanks WCI.

    I've since been following much of the advice I've read here (read the book) and am fixing up my financial house.  I have a particular problem that I couldn't find specific advice on and was hoping for a few thoughts / ideas from the group.

    I'm in another high income profession (Tech).  My employer (MSFT) gives out annual stock awards.  I've saved all of them I've been granted for quite a while (years) without thinking too much about them -- my rather thoughtless retirement plan (yes, I also have a reasonable diversified 401k as well).

    My problem is that I have nearly $600k in unrealized gains in my taxable account concentrated in MSFT stock.  All but about $30k is long term gains (@20%).  In total, this one stock represents about 1/3 of my net worth.

    I'll be attempting to diversify into my preferred asset allocation, but I wondered if anyone had any particular advice on the best way to do it -- timeframe, DCA, method, etc.

    I was even looking into WealthFront's Selling Plan feature which does automatic DCA over time -- given the large capital gains, tax loss harvesting to cut down on the tax bill might be useful, but I have no idea how much harvesting would be reasonable to expect from a robo over what timeframe or if such a solution would even be worth the 0.25%.

    Any advice is much appreciated.

     

  • #2
    Typically you want to keep your holdings in any one stock to 10% or less. If you get discounted stock, you want to get as much of that as possible, then set up a systematic plan to move out of that position after any mandatory holding period. (If you were high enough in the company that there'd be an SEC filing when you sold MSFT stock then things might be different.)

    Do you give money to charity? If so, a donor advised fund could help with this problem. Are you likely to retire early, take a sabbatical, or have an unpaid or partially paid year due to maternity / paternity leave or grad school? If so, then that could be a good time to unload some of your stock.

    You want to get from $600K down to about $180K. That's $420K to unload, so you won't want to do it all at one time. Hopefully MSFT and the rest of your portfolio continue to grow well, so this is a moving target.

    Talk with your CPA or tax advisor and see what other folks on WCI suggest. I think you want to use a DAF and the stepped up basis at death for transfer to spouse and kids in order to deal with the shares with the very lowest cost basis. Set up a systematic plan to unload new shares as quickly as allowable to minimize future taxes. Look for opportunities to tax loss harvest for the shares that are in the middle on cost basis (not too high, not too low).

    Ballpark, I'd think you'll need 3-5 years to wind down your excessive holdings in your company's stock. Microsoft employees have been laid off in the recent past, so you don't want to face the double-whammy of a third of your portfolio taking a dive (beyond what the rest of the market is doing) while your employment is up in the air or worse.

    On the plus side, you're paying long term capital gains in a state with no state income tax. You made money, so there are worse problems to have.

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    • #3
      First world problem.  My older brother had this same issue with IBM stock.  He felt he was being disloyal if he sold any of the discounted shares.  He lost a lot of money in the 1987 crash because of this.  He learned his lesson and diversified. Hank above is giving good advice.  Set up a DAF if you are charitable.  With the next correction unload some losing lots and take a tax deduction.  I would not reinvest dividends.  If you have no losing lots then systematically sell your higher cost lots first.  Take your time this problem did not occur over night.

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      • #4
        What tax bracket are you in? Do you have children? You have some tax planning opportunities, especially if you can gradually gift the stock to children, they sell, and then fund 529 accounts to grow tax free for college. That combined with gradual liquidation in your name up to the 35% tax bracket ($470,400 taxable income) to stay in the 15% LTCG rate band will help you diversify with minimal tax harm. Of course, you need to consider the kiddie tax and coordinate your strategy, so it can't be done all at once. This is where a good CPA will pay for any fees multiple times over.

        As others have mentioned, a DAF will allow you to front-load future contributions. So by gifting enough to the DAF to reduce your taxable income to stay in the 15% LTCG bracket, you can exercise a measure of control and use the DAF for donations in lower income years.

        Your top priority at this point, however, is to diversify, even though you'll have to pay taxes. The risk of permanent loss far outweighs the tax costs.
        Working to protect good doctors from bad advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

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        • #5
          You definitely need to diversify and reduce your exposure to MSFT. Until you can do so, I would recommend using options to create an Equity Collar on your MSFT stock.

          An Equity Collar involves the purchase of a long-dated put option plus the sale of a long-dated call option - on the concentrated stock position. The collar should leave enough room for potential gains and losses, so it is not construed as a constructive sale by the IRS and subject to taxes.

          The put option would provide downside protection. The sale of the call option provides the you with premium income that they can use to pay for the purchase of the put option.

          This would protect you, in the event of a market correction, while you unwind your MSFT position.

          Other here have provided some excellent ideas on how to divest yourself of your excess shares.

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          • #6




            You definitely need to diversify and reduce your exposure to MSFT. Until you can do so, I would recommend using options to create an Equity Collar on your MSFT stock.

            An Equity Collar involves the purchase of a long-dated put option plus the sale of a long-dated call option – on the concentrated stock position. The collar should leave enough room for potential gains and losses, so it is not construed as a constructive sale by the IRS and subject to taxes.

            The put option would provide downside protection. The sale of the call option provides the you with premium income that they can use to pay for the purchase of the put option.

            This would protect you, in the event of a market correction, while you unwind your MSFT position.

            Other here have provided some excellent ideas on how to divest yourself of your excess shares.
            Click to expand...


            Even just selling a covered calls with the portion and over the time period you want to draw down is a great plan for it. Gives premium and your shares will start to decrease every now and then. Change strike/time to adjust how much/often you actually sell.

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            • #7
              Personally I'm not against holding a lot of a single stock, particularly if it's in a quality company you innately know and understand.  You obviously don't want to be the guy whose entire retirement portfolio is held in enron stock, but even at this point that's not you.

              If you have any holdings with losses, you could sell MSFT to the extent of those losses and it would be a wash.  Or you can just take the 20% hit, perhaps in small bites.  Don't let the tax tail wag the dog.

              The option proposal FS gave above is slightly more complex but would work well to hedge against future loss and eventually reduce the size of your holdings.  You could potentially take the whole tax hit at once depending on if those calls are all executed though.

              Again, don't let taxes make all your decisions for you.  Really, a portion of your holdings simply belongs to the tax man, whether or not you sell it today.  Unless you know you're going to have a lot of offsetting losses, or unless you want to give it all away, paying taxes is an inevitability.  Take the deductions you can, render unto Caesar and move on with your life.   

               

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              • #8
                Okay, thanks everyone for everything so far -- here's the follow-up questions that were asked:

                We do some charitable giving, but most giving goes in support of various elder extended family members.  DAF could be an interesting option though for at least a portion of the money -- I'll take a look.

                We have two grade school children -- one 529, one with GET credits.  I'm in my early forties, I'll probably retire somewhere around 55-60.  I don't anticipate any low income years between now and then.  I'm in the top marginal bracket and won't be able to get out of it until a year or two after retirement due to the way company stock distributions work.  Given my position, its highly unlikely I will be susceptible to layoff.

                Thanks for all the info on covered calls and the equity collar -- can't say as I had considered options at all up to this point.

                I feel no particular need (and have no requirement) to stay with the stock position, so I'm looking for the right way to diversify --> at least the way with the fewest tax consequences while managing risk.  At the end of the day, though, you're right:  a portion will belong to the tax man.  I'd just rather figure out a way to pay as much as I can later (or not at all), rather than all at once.

                Either way, I'm just trying to ensure I have a good picture of what all the options available are.  Truly appreciate the suggestions so far.

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