concentrated position risk: when one holding is most of your wealth

In short

I once watched a neighbor of mine stand in his driveway and say he would never need to sell a single share of the company that employed him. If you are holding a lot of one stock, you may feel much the same way. That feeling is natural, and it comes from a good place. Still, when one holding is most of your wealth, one bad year at one company can change your whole life. The simple fix is to learn the size of your position, learn what a sale would cost in tax, and then make a plan you can live with. Many people spread the risk out slowly over several years. Others use tools that let them keep some upside while limiting the loss. None of this is a call to act today. It is a call to look at the numbers first.

The whole of it

What it is

A friend of mine spent thirty years at one manufacturing firm, and she took part of her pay in company stock every year. One morning she added up her accounts and found that nearly all her savings rode on that single name. That is what people call a concentrated position. It means one holding makes up such a large share of your wealth that its bad day becomes your bad day. There is no single percent that the law sets for this. Many advisers start to worry when one stock grows past a fifth or so of a person's total holdings, but that is a rule of thumb, not a rule of law.

Why does it happen? Stock grants, an employee stock purchase plan, an inheritance, a business sale, or plain good luck. A stock that doubles twice can swallow a portfolio without anyone making a bold choice. It just grew. Nobody is to blame for that.

Here is the part that stings. If you work for the company, you carry the risk twice. Your paycheck and your savings depend on the same firm. When the company stumbles, the job and the stock can go down together. That is the real heart of the matter.

How it works

You have probably heard that a single stock can be riskier than the whole market. The reason is simple. A broad fund holds hundreds of companies, so one failure barely moves it. A single stock has no such cushion. It can fall by half and take years to climb back, or never climb back at all.

Selling brings its own cost, and that is why people stall. If you sell shares in a regular taxable account for more than you paid, the gain is taxed. Shares held more than one year get long term capital gains rates. Shares held one year or less get taxed as ordinary income. The rates and the income brackets change by year, so the Internal Revenue Service publishes them. The top long term rate is the current figure, which the official source publishes each year and the extra tax on net investment income is the current figure, which the official source publishes each year for higher earners.

Some people spread sales over several years to keep each year's gain in a lower bracket. Some give shares to charity or to family, which can avoid the gain in certain cases. Some use an exchange fund, where many holders pool their shares and swap into a basket. Others use a collar, which means buying a put option to limit the loss and selling a call option to pay for it. Each of these tools has fees, limits, and fine print. A tax professional can tell you which ones fit.

Employees face extra rules. Company insiders may only trade during certain windows. Shares from stock options have their own tax timing. The plan documents control what the employee may do, so read them.

The numbers, and where to find yours

Start with two numbers, and you can find both in an afternoon. The first is the market value of the position. Your brokerage statement shows it. The second is your cost basis, which is what you paid for the shares, or their value on the day you received them. Your statement or the plan administrator's records list it, and Form 1099-B shows it after a sale.

Then divide. Take the value of the one holding and divide it by the value of everything you own. That gives your concentration percent. Be honest about what counts as everything. Include retirement accounts, bank accounts, and a business if you own one. Many people leave out the house, which is fair, but say so out loud so you know what you counted.

Next, work out your gain. Subtract the basis from the value. That gain is what the tax would apply to. The Internal Revenue Service explains the holding period and the rate brackets in Publication 550 and Topic number 409 on irs.gov. The current brackets are the current figure, which the official source publishes each year. Look up your own filing status there.

A worked example

Let me tell you about a woman I will call Dana. She is fifty one and a project manager at a software company. Her salary is $140,000. Over twelve years she gathered 4,000 shares of her employer through stock grants and a purchase plan.

The stock trades at $60 a share. Her position is 4,000 shares at $60, which is $240,000. Her other savings are $110,000 in a retirement account and $30,000 in a bank account. Her total is $240,000 plus $110,000 plus $30,000, which is $380,000.

Her concentration is $240,000 divided by $380,000. That is about 63 percent. Nearly two thirds of her wealth rides on one firm, and her paycheck comes from that same firm.

Her cost basis averages $20 a share. So her basis is 4,000 shares at $20, which is $80,000. Her gain is $240,000 minus $80,000, which is $160,000.

Suppose she sold all of it in one year. She would owe long term gains tax on $160,000. At a flat 15 percent for the sake of the example, the tax is $160,000 times 0.15, which is $24,000. Her real rate may differ, and part of the gain could land in a higher bracket. So she would keep about $216,000 after tax.

Now suppose she sells in four equal steps over four years. Each step is 1,000 shares. Each sale brings in $60,000 and carries a gain of $40,000, since 1,000 shares times $40 of gain is $40,000. At 15 percent, each year's tax is $6,000. Four years of $6,000 is $24,000 again, so the total looks the same at a flat rate. The real gain from spreading is that each year's gain may stay in a lower bracket. And her risk comes down a step at a time.

Dana also asked what a drop would do. If the stock fell 40 percent, the price would be $36. Her position would be 4,000 times $36, which is $144,000. She would lose $96,000. Her total would fall from $380,000 to $284,000, a drop of 25 percent from one stock alone. That number, more than any chart, is what got her to make a plan.

Where it goes wrong

A man I know waited for the stock to get back to its old high before he sold anything. It never did. This is the oldest trap. People anchor to a price in their heads, and the market does not care about that price. Hope is warm company, but it is a poor plan.

Another mistake is letting the tax tail wag the dog. Nobody likes writing a big check to the government. But a tax bill on a gain is a bill on money you already made. A loss from a collapsing stock is money you will not get back. Weigh the two with a clear head.

Some people sell in a panic after a drop, which locks in the loss at the worst moment. Others forget the rules that bind them. The company may limit when an employee can sell. The plan may require a holding period. A trading window may be closed. The seller has to follow those rules or face penalties.

Watch the wash sale rule too. If a taxpayer sells at a loss and buys the same stock within thirty days, the loss is disallowed for now. And be careful with fancy tools. An exchange fund may hold shares for a set period, and the fund's documents state how long. A collar can cap your gains. Fees add up. Read every page before signing.

Last, do not forget the human part. It is hard to sell a stock that built your house. Go easy on yourself. Wanting to hold on is not foolish. It just needs a plan beside it.

Questions to answer before you leave this page

What share of your total wealth sits in your largest single holding, and did you count every account when you worked it out? What did the shares cost you, and what would the tax be on a sale at today's price, using the brackets on irs.gov? If your employer is also the stock, what happens to your paycheck and your savings together if the company has a bad year? Does your plan, or your employer's insider policy, limit when and how much you may sell? Could you live with selling in steps over a few years, and what size of loss could you bear if the price fell by a third? Have you talked to a tax professional about gifting, exchange funds, or other tools, and what would each one cost in fees and limits?