Portfolio Diversification Can Minimize Stock Market Risk: Financial Advisor Urges Investors to Unwind Highly Concentrated Stock Positions
Most Americans who invest in stocks know that market volatility and stock price fluctuation are normal and to be expected. But according to financial professional Chanie Schwartz, they also need to understand that maintaining a diversified portfolio is important. "The old adage 'don't put all your eggs in one basket' is still good advice," Schwartz says. "Anyone in doubt should ask an Enron employee."
New York, NY (PRWEB) April 9, 2008 - Most Americans who invest in stocks know that market volatility and stock price fluctuation are normal and to be expected. But according to financial professional Chanie Schwartz, they also need to understand that maintaining a diversified portfolio is important. "The old adage 'don't put all your eggs in one basket' is still good advice," Schwartz says. "Anyone in doubt should ask an Enron employee."
Most concentrated stock positions result from equity compensation given to corporate executives that can be in the form of restricted stock, stock appreciation rights and restricted stock units, to name a few. An employee's concentration in a stock can also add up due employee stock purchase plans or because the company offers its stock as an investment option in their 401(k) plan (the company might even do their 401(k) match by providing company stock).
The problem is that investors can become attached to stocks, specifically their employer's stocks, and feel that they are being disloyal to the company if they sell some of their shares. "It might be
that they worked for a large corporation such as IBM or Exxon Mobil and acquired a major portion of their wealth in the form of stock options," explains Schwartz. "Or maybe they just fell in love with their employer's stock and bought a ton of shares over the years through the Employee Stock Purchase Plan. If, in her will, Aunt Bertha left a large block of Caterpillar stock - something she worked hard for and acquired over 30 years - there could also be a different type of emotional attachment."
Still, Schwartz says it may be necessary to sell some shares to maintain a healthy and properly diversified portfolio. Market losses can be exacerbated when a portfolio holds too much of a particular stock or is skewed heavily into any one market sector. The issue of concentrated positions is compounded if an investor is planning to retire within the next 10 years. "They just don't have time to recover from large share value loss," says Schwartz.
To strategically unwind a concentrated portfolio, Schwartz offers the following tips:
Use Share Selection
Share Selection involves liquidating a large portion of a concentrated stock position now and taking advantage of the low 15 percent long-term capital gains rate. "Savvy investors will sell the shares with the highest cost basis, thus minimizing overall capital gain," says Schwartz.
Roll Out into a Taxable Account
Taxpayers may benefit from an important break on income tax when they take a lump-sum distribution from a 401(k) plan. A lump-sum distribution means the entire balance of the account is withdrawn within a single calendar year following a triggering event - you leave your employer, suffer a disability, reach age 59½ or die. (Note that if you leave your employer before you turn 55 and you take a lump-sum distribution rather than rolling the funds into another qualified account, you may be subject to a penalty.)
If the distribution meets the definition of a lump-sum, you may be able to avoid income tax on the net unrealized appreciation (NUA) of the stock of your employer if that stock is placed into a taxable brokerage account and the remaining 401(k) assets are rolled into an IRA. The strategy involves an employee taking a lump-sum distribution of company stock from their retirement plan (upon separation from service) and then paying ordinary income taxes on the stock's basis. But the difference between the basis and the fair market value--the net unrealized appreciation--is taxed at long-term capital gains rates only when the stock is sold, regardless of the holding period. This can be a better option than rolling the stock into an IRA where all of its value will eventually be taxed as ordinary income.
"This special consideration for employer stock held in 401(k) plans only applies to lump-sum distributions, but it could save significant income tax," Schwartz says.
Consider a Gifting Strategy
Another good strategy to consider is gifting the stock to children/grandchildren or a favorite charity. Under current laws, an individual can gift up to $12,000 per year, to anyone they choose, without incurring gift taxes. A charitable gift should qualify as a tax deduction. Transferring highly appreciated stocks to a Charitable Remainder Trusts (CRT) allows an investor to receive both a charitable deduction and an annual income stream from the trust.
While in general it is wise to think long-term and give your investments time to perform, that message is sometimes taken to the extreme, warns Schwartz. "Regardless of how it happened, any individual holding that makes up more than 25% of your overall investment holdings is considered a concentrated position. And that position needs to be rectified in order to maintain portfolio health."
Because individual situations will vary, investors should contact their tax advisor about their specific situation.
About Chanie Schwartz and A Vested Interest Wealth Management
Chanie Schwartz is a wealth manager with Securities America Advisors. She specializes in executive compensation and benefits, asset allocation, retirement planning, college funding strategies and estate conservation strategies. Chanie has been serving a select group of highly-successful executives in the New York area for close to a decade. Chanie was employed at Morgan Stanley before founding A Vested Interest Wealth Management.
Chanie Schwartz graduated cum laude from Brooklyn College with a BS in Business, Management and Finance. She successfully completed the demanding requirements to become a CERTIFIED FINANCIAL PLANNER™ professional through the Certified Financial Planner Board of Standards, Inc.
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