April 25, 2017
Many successful executives possess wealth that is tied directly to their company’s stock. When the company thrives, these individuals’ wealth — and their accumulation of that stock — increases.
“Ideally, a portfolio will never have more than 10 percent of its assets in any one stock,” says Bryan Polley, Vice President of Wealth Management for The Private Client Reserve of U.S. Bank in Minneapolis. Yet for executives who receive company stock as incentives, bonuses and 401(k) contributions, it can be easy to lose that diversification. In some cases, Polley has seen investors with more than 90 percent of their net worth tied up in company stock.
If something goes wrong with the business or the marketplace, the value of that stock can quickly disappear, causing once-wealthy investors to lose a sizable portion of their holdings. Consider the lessons learned from the Enron collapse in 2001-02 or the crash of British Petroleum’s stock after the Deepwater Horizon oil rig disaster in 2010. “Those were unexpected events, and for investors with large concentrations of stock, their portfolios were decimated,” Polley says. A less extreme but equally impactful circumstance could involve expiration of executives’ stock options or the sale of the company, forcing them to sell all their stock at once and take an enormous tax hit.
The challenge for these investors is figuring out how to get out from under a burdensome stock concentration while minimizing that sudden tax burden. “Inevitably, investors have to pay taxes on stocks they sell,” Polley says, but they can spread the impact out over time and take advantage of potential money-saving choices to lessen the hit.
Investors should consider working with their financial advisor and CPA to create a road map for slowly diversifying their portfolio over time. While diversification does not guarantee returns or protect against losses, it can help reduce portfolio volatility and the risk of returns associated with an individual holding.