Strategies to Manage a Concentrated Stock Position and Diversify Your Portfolio

In contrast, a diversified portfolio, spanning sectors, industries, and asset classes, helps distribute the risk that concentrated holdings introduce. If one holding falls, others may hold or rise. Concentrated portfolios lack appropriate diversification which is why they pose a significant risk.

Diversification can help smooth returns by spreading risk and improving the chances of participating in the growth of the best-performing stocks over time. In contrast, relying on a single stock introduces far more volatility and downside exposure without the built-in resilience that comes from spreading risk across sectors and companies.

Here’s why concentrated positions pose such a significant risk:

Idiosyncratic Risk: A concentrated position exposes you to company-specific events such as leadership changes, lawsuits, or product failures that can erase years of gains overnight.

Market Risk: While market risk is inherent in all investments, regardless of level of diversification, concentrated positions can amplify those risks.  With your portfolio heavily tied to the price of one stock, any downturn in that company can disproportionately impact your financial future.

Liquidity Constraints: Equity compensation, such as RSUs or restricted stock, often comes with sale restrictions, making it difficult to rebalance or sell when markets turn volatile.

Tax Exposure: Selling a large position can trigger substantial capital gains taxes, potentially pushing your adjusted gross income higher and increasing your overall tax burden.

Why Investors Hold on to Concentrated Positions

Many investors with concentrated positions are hesitant to diversify. Reasons may include:

• • Emotional attachment: You believe in the company, helped build it, or still work there.
  • Tax concerns: Selling may trigger a high capital gain and increase your income tax or adjusted gross income.
  • Past performance: It’s tempting to hold onto what has worked.
  • Lack of awareness: Some investors don’t realize just how much risk they’re carrying.

Whatever the reason, holding too much of one security may expose you to unnecessary risk. Fortunately, there are ways to diversify a concentrated position without sacrificing growth or control.

Strategies for Managing a Concentrated Stock Position

Reducing concentration strengthens flexibility, improves tax efficiency, and lowers risk. Reducing concentration may strengthen flexibility, improve tax efficiency, and reduce risk.

1. Gradual Diversification Over Time

A common approach to reducing concentration risk in stock holdings is incremental sales spread over multiple tax years.  This helps to:

• • Reduce tax exposure by gradually managing realized capital gains and offsetting them with tax loss harvesting(when possible).
  • Lower annual impact on adjusted gross income, potentially keeping income in lower tax brackets
  • Take advantage of market fluctuations to manage timing and risk
  • Maintain ownership throughout the diversification process

There are many ways to approach this, and your advisor can help implement a custom strategy based on your financial condition and individual risk tolerances. At NEPWA, we often find two strategies particularly effective:

1. Direct Indexing

Instead of owning an index mutual fund or ETF, an investor can open a direct indexing account. These accounts seek to mirror the performance and risk profile of an index, such as the S&P 500, by directly holding a carefully weighted portfolio of the index’s individual stocks.

A key advantage to this type of approach, rather than purchasing an index fund equivalent, is the ability to harvest losses at the individual stock level. Realized capital losses from selected holdings can create a valuable tax asset, which may then be strategically used to offset capital gains from the sale of a business, a concentrated stock position, or other appreciated assets.

2. Tax-Aware Long/Short Strategies

Tax-aware long/short strategies use both long and short stock positions to build a diversified portfolio focused on improving after-tax returns. These approaches introduce added complexity such as leverage, short positions, and a higher tracking error compared to direct indexing.

However, they can also deliver greater potential pre-tax outperformance and more persistent tax benefits. Like direct indexing, these strategies can capture realized losses in individual stocks, creating tax assets that may be used to offset future capital gains.

Both Direct Indexing and Tax-Aware Long/Short Strategies offer flexibility in the account funding source. This could be cash, in-kind security transfers, or a combination of both.

2. Charitable Giving Strategies

If you have appreciated stock, giving a portion of it to charity may offer a tax deduction while helping you reduce exposure.

Charitable Remainder Trust (CRT)

A Charitable Remainder Trust allows you to transfer appreciated assets, such as stock, into an irrevocable trust. The CRT can sell the stock without paying immediate capital gains tax, preserving more of your investment for future growth.

In return, you or another beneficiary receives an income stream for a set term or life. The payment amount depends on the trust type: a Charitable Remainder Annuity Trust (CRAT) pays a fixed amount annually, while a Charitable Remainder Unitrust (CRUT) pays a variable amount based on the trust’s value and investment performance.

Note that although the CRT itself is tax-exempt, the income distributed to the beneficiary is taxable and must be reported as ordinary income in the year it is received. Additionally, establishing a CRT provides an immediate charitable income tax deduction based on the present value of the remainder interest designated for charity. After the trust term ends — or upon the death of the income beneficiary — the remaining assets are transferred to the named charitable organization.This approach has practical income and tax advantages and may be of specific interest to those who are philanthropically inclined.

Donor-Advised Fund (DAF)

A Donor-Advised Fund is another versatile charitable giving tool. When you contribute “long-term” appreciated shares to a DAF, you receive a tax deduction at the time of the contribution based on the fair market value (FMV) of the stock. The tax deduction may be limited based on adjusted gross income (AGI). The DAF can then liquidate the holdings without immediate capital gains tax and invest the proceeds for future grants to selected charities.

This structure offers flexibility, enabling you to recommend grants over time rather than all at once, making it ideal for ongoing charitable strategies or long-term philanthropy. It can be especially beneficial to fund a DAF in a high-income year, such as after selling a concentrated stock position, to maximize your tax deduction.