Concentrated positions can result from various factors including business acquisition, inheritance, incentive compensation and even outsized growth. How can you start a diversification conversation—and move it forward—when clients do not consider the concentration a risk? We suggest a three-step approach: Celebrate. Ask. Remind.
Instead of leading with how a failure to diversify could jeopardize clients' plans for a comfortable retirement, start by acknowledging the success your client has had with the concentrated position, as it may very well be a significant source of their wealth.
Consider saying: "Your success with this stock is impressive. Its growth over the years has certainly set you up for future success."
Next, ask your clients if they are open to discussing how the concentration fits within their overall wealth plans going forward. If they say yes, they are inviting you to discuss the topic as opposed to you pushing them into the conversation.
In the event they say no, consider saying, "I understand. As your advisor, I want to keep an eye on anything that could impact the success of your financial plan. We can revisit the conversation when you are ready."
Finally, remind clients that not all shares are created equal, especially from a tax perspective. Help clients understand the following tax nuances across the different types of concentrations:
- While there may be benefits to holding shares received through the exercise of incentive stock options or shares of employer stock held in a 401(k), there are little to no tax benefits to certain forms of incentive compensation such as shares acquired through restricted stock units or nonqualified stock options.
- Shares received through inheritance have different tax implications than shares received as a gift. Shares received by inheritance most likely received a step-up in basis and may be able to be diversified through sale with minimal income tax consequences. Shares received by way of a gift during the grantor's lifetime most likely did not receive a step-up in basis and may carry large built-in gains, making a sale less appealing.
- Certain concentrated positions may be eligible for diversification through a tax-deferred exchange fund, allowing a client to defer taxes until the sale of the stock or hold the shares until death in order to receive a step-up in basis.
When clients understand these tax nuances, they may be more open to diversifying concentrated positions.
Bottom Line: When it comes to driving concentration conversations forward, use this three-step approach: Celebrate. Ask. Remind.