Concentrated Wealth: A Guide

Setting the scene

From refining your skills, to gaining expertise in your field, you have spent years, decades even, working towards the peak of your career, and it's likely that your professional achievements have also come with some financial benefits.

Does equity compensation ring a bell?

While equity compensation can mean financial security on the one hand, it also can be quite complex and come with some serious risk, making it incredibly important to fully comprehend ahead of time.

We've all heard the old saying, "don't put all your eggs in one basket," right? Today, we're going to discuss a similar concept: concentrated wealth.

What is concentrated wealth?

Like the name suggests, a concentrated stock position is generally defined as any position greater than 10% or 20% of a portfolio. It can alternatively be described as the size of an individual position that could negatively affect your financial plan (between 5%–50%). For these reasons, concentrated stock can be quite risky. For example, if the company you have invested in falls out of favor, is poorly managed, or is heavily regulated, it may underperform, ultimately resulting in a financial loss on your end. Additionally, if the company you have invested in goes bankrupt, you run the risk of your stock value dropping to zero, which is the kind of risk most people simply aren’t willing to take on.

That's not to rule concentrated wealth out, though, as with great risk can come great reward.

If you are considering investing in concentrated stock, it's especially important to weigh any potential associated risks, as well as to understand the basics behind equity compensation as a whole.

The basics of equity compensation

Equity compensation is a non-cash payment offered to employees that represents ownership in a company.

How you manage your equity compensation will likely be based on the type of compensation package you have, be it an employee stock purchase plan, restricted stock unit plan, or stock option plan. In order to figure out just how equity compensation fits into your financial picture, you should keep the following in mind:

  • Understand the impact of recent tax law changes on your wealth and consider the tax consequences of your investment decisions. It's important to understand any recent tax laws, as well as the nuances of both qualified (incentive) and non-qualified stock options, as the two are treated differently tax-wise.
  • Understand what kind of investor you are. It's also important to identify any long-term and short-term financial goals and establish the threshold of risk you're comfortable with. Considerations could include retirement, college, and other long-term milestones.

Assessing risk/reward

A large single-stock position gives investors a riskier risk/reward profile, so it’s important to keep certain factors in mind, such as the liquidation cost (including any tax and transaction costs), your time horizon, your risk tolerance, the overall risk to your portfolio, and historical volatility. If after assessing all of these various factors, you still do not see the desired amount of return, it’s time to diversify.

How to diversify a concentrated stock position

It's been said that concentrated wealth makes people wealthy, but diversified wealth keeps them wealthy. Between the high level of risk associated with single-stock positions and the tax implications if the investor decides to sell the entire position, it's important to use certain strategies to diversify and, as a result, minimize the risk to your net worth.

  • Donor-Advised Fund: A donor-advised fund (DAF) is an account that exists through a public charity for accepting charitable gifts. DAFs can prove beneficial for several reasons, such as shares can be sold without encountering a capital gains tax, the donor can have funds managed by a financial advisor, the donor can get an income tax deduction equal to the shares’ fair market value on the date of contribution, and they are usually less expensive and simpler to establish and maintain.
  • Charitable Remainder Trust: A charitable remainder trust (CRT) is a split-interest trust that benefits two kinds of beneficiaries simultaneously. First, it benefits a non-charitable income beneficiary (often the concentrated stock owner) who receives a stream of income throughout the term of the trust, and second, it benefits a charitable organization that gets all of the remaining trust assets once the trust term ends. Additionally, CRTs are tax-exempt, making them a great option for receiving and liquidating contributions of concentrated stock positions.

Other options include structured stock selling (selling the stock or a portion of the stock outright), exchange funds (which allow you to pool your concentrated stocks with other investors in a fund, helping to diversify your positions and minimizing taxes), stock protection plans (which involve investors holding stock from diversified industries pooling their money together), donating concentrated stocks to a private foundation, and gifting stock to family members.

Now what?

I know that concentrated wealth can feel overwhelming, but all problems have various solutions, and my job is to find one that is right for you and your family. With the right strategy in place, you can rest assured knowing that your equity compensation package is set up to generate financial security for the long term. My commitment to providing you with comprehensive wealth management solutions is unwavering. If you have questions about your concentrated stock position, please feel free to reach out.