Concentrated Stock

An equity that makes up to a considerable part of the investor’s portfolio which may usually be above thirty percent is known as concentrated stock. Such a stock is highly risky because it is devoid of diversification. The performance of the stock could highly affect the wealth of the investor holding large number of shares. Such stocks are retained by the investor due to emotional attachment to a company, desire to inherit and restrict it from being sold. Though concentrated stock is highly desirable, it is best to use safety measures to handle it aptly and avoid related perils.

The strategies regarding concentrated stock and related risks

When a person gets high returns from a particular stock, he tends to buy more of it in the following years. One may also retain the portfolio because they do not wish to pay tax on capital gains. An investor needs to be cautious about the dangers of having single stock ownership. Since a large portion of individual wealth is involved in it, the risk associated with its performance is highly volatile. Hence diversification of portfolio is much advised where individual wealth is prone to less risk.

Safety measures related to concentrated stock

While purchasing large amount of single company share, it should be selected carefully so that one could sell it with highest cost basis and minimize overall capital gain. When the holder decides to sell three fourth of the shares in the next five years, he should spread the sales equally through the time period so that capital gains tax faced in a particular year is low. To avert the tax, one could also gift the shares to children, dear ones or charity which may be free of gift tax up to a particular amount.

One could use strategies to maintain their wealth, delay tax and diversify their investments at the same time. When a stock is transferred to charitable trusts, one gets tax deduction and annual income from the trust at the same time. A collar is a provision where the individual concentrated position is safe within the minimum and maximum limits for the particular period covered by the option. Limited partnership entitles the investor to hold other stocks and have a more diversified portfolio.

Prepaid Variable Forwards which resembles collar entitles the investor to receive and upfront payment in lieu of variable amounts of shares or cash in future. Such a forward contract shields the investor from decline in share price in the future.

Questions:

• Explain concentrated stocks.
• Explain the strategies involved in concentrated stocks.