When your employer’s stock accounts for a large portion of your net worth, there are reasons to consider taking some gains. Emotionally, most people struggle to effectively exit a winning position, but doing so is extremely important for capturing reasonable upside while mitigating downside risk.
There are many reasons why a single company’s stock price can drop precipitously, even for respected and successful firms. In the unlikely case this would happen to your favorite stock or employer, do you want to potentially sacrifice your successful retirement by hanging on to every share you’ve purchased or earned? We often remind people that when their favorite company’s stock appreciates, it’s likely many others will, too. Further, a single stock’s price fluctuates much more significantly than does a diversified portfolio that includes many industries.
For this reason, a disciplined selling strategy is the key to working with any stock in which you own a large position. A few key considerations:
• Decide how much exposure is too much
• Consistent with your goals, create a well-defined action plan to trim the position as it exceeds your maximum exposure
• Remember that because you invest your human capital with your employer, investing the bulk of your financial wealth in the same company concentrates your risk
• Equity-based compensation, deferred compensation, or your future pension benefits tied to your employer’s success should be all treated as employer-invested, future wealth
When you’re ready to reduce exposure, consider the following strategies SYM advisors recommend to clients with concentrated holdings.
Gift Highly Appreciated Shares
If you are charitably motivated, you might consider gifting gifts funded by highly appreciated securities. At SYM, we suggest this strategy for contributions that exceed a few thousand dollars. If you have investments up 50% to 100% or more, you can reduce your future capital gains taxes by donating them to charities.
The charity is not required to pay taxes on the gains and, if executed properly, you can also deduct the full fair market value of the gift while permanently removing the deferred capital gain from your portfolio. The additional tax benefit of this strategy could approach 20% of the value of the gift.
Sell Using Limit Orders (Patiently accept gifts from the market)
In order to avoid making decisions when emotions are high, determine certain prices at which you would be comfortable selling shares. Revisit your decisions only every 6-12 months so you don’t keep moving your target higher as the stock appreciates. Then, set limit orders that are good until cancelled, which means the order will be in place until the price triggers a sale or until the sale order expires (generally 30-90 days after placing).
Exercise Executive Stock Options
If you receive stock options as part of your compensation, view this long-term pay as an opportunity to participate in upside which you help create through your efforts. At SYM, we discuss this with executive clients annually to determine how many options to sell if the stock reaches defined target prices. While not always the case, it’s common to exercise options with a 10-year horizon between years 5 and 8. Exercising options regularly is an important part of a diversification process, which migrates large swings in your net worth.
Write Covered Calls
This strategy should be limited to investors experienced with stock options or who have an experienced advisor with the experience to act on your behalf. We prefer this approach only if the intent is to sell 5,000-10,000 shares or more.
With a covered call, you sell someone the upside on your shares above a set price (the strike price) and until a specific day in the future. You receive a small premium for selling this right, which you particularly enjoy if stock price decreases or remains unchanged. While you keep the premium if the stock price increase dramatically, you share the upside with your counterparty.
Using this strategy, you are “paid to wait” for the upside in your stock. Writing covered calls is best considered after one has already gifted or sold enough shares to diminish the risk of the concentrated positions and wants to take a more measured approach to future sales. However, it’s important to note that while waiting for the upside, you might miss an opportunity to sell and realize larger gains in a more diversified portfolio.
Today’s decisions can have a profound impact on your future lifestyle. Though there is a chance that by employing the above strategies you may sell before a peak, we still firmly believe that clients are best served by methodically reducing exposure to concentrated risks.
As with any planning decisions, consider your circumstance and consult with your accountant and/or financial professional before acting. If you are employed by a public company, ensure compliance with your company’s trading restrictions.