Talking Taxes: Navigating the Concentration Conversation

A common challenge many investors face is the accumulation of a single stock that makes up a disproportionate share of their total net worth, often due to incentive compensation, inheritance or an investment that has outperformed their broader portfolio. While these concentrations are often a sign of your clients’ success, the reality is most individual stocks underperform broad market indices over time and can introduce outsized risk and significant volatility.

Diversification¹ isn’t simply a financial decision—it’s a behavioral one as clients often face common biases such as overconfidence, loyalty to the company, anchoring to a prior price or fear of tax consequences. Navigating the concentration conversation with clients requires both technical planning and thoughtful coaching. Here are a few open-ended questions to help start the conversation:

• How do you envision your position contributing to your future financial goals? Clients may express biases when you point out the risk associated with their concentration. By asking this question, you’re inviting them to discuss their thoughts rather than pushing them into the conversation.
• If this position were replaced by cash overnight, how would you redeploy that cash? Would you buy back the total amount of that stock? Posing a hypothetical situation can help illuminate that their inaction may be based on cognitive biases. If handed cash, they may not choose to replicate the current allocation. If clients answer that they would not buy back 100% of their stake in the company, they have opened the door to discuss diversification strategies for a portion of the holding.
• Rather than fully divesting your company stock, how would you feel about diversifying shares that don’t come with any tax advantage? For client’s receiving incentive compensation, engage in a conversation about the tax treatment associated with different forms of incentive compensation. Remind clients that not all shares are created equal. There is no tax reason to hold certain shares, like restricted stock units, given that they are taxed as ordinary income when they vest.

Once clients are open to discussing the benefits of strategic diversification, leverage the HOPES framework to explore possible solutions to address concentration risk:

• Hold: Help clients determine a prudent hold target and how the position may impact risk and long-term financial goals.
• Options and derivatives: Various overlay strategies, such as selling calls, buying puts, collaring or using variable prepaid forwards, can help modify the risk profile of the concentration, help generate income or help monetize the position for suitable investors.
• Planned giving: By funding philanthropic initiatives with concentrated stock instead of cash, clients can avoid capital gains recognition, keep cash on hand and may benefit from an itemized deduction.
• Exchange funds: For qualified clients, an exchange of shares can offer a path to immediate diversification without triggering a taxable event. They are frequently funded with a client’s most appreciated shares to help maximize the benefit of tax deferral.
• Strategic selling: Prioritize selling specific tax lots to help minimize the upfront tax consequences. Clients can also deploy a staged diversification strategy—liquidating shares over multiple tax years to spread out the tax friction over time. When stock is sold, the after-tax proceeds can be redeployed into a more appropriate asset allocation. This can open the door to a conversation about incorporating tax management to help alleviate some of the tax friction from a strategic liquidation plan.

While there’s no single solution to address the complex planning objectives of high-net-worth clients, the HOPES framework can help diversify your diversification strategy and provide clients with a blueprint for balancing conviction, risk and investment goals.

Bottom line: Asking open-ended questions and leveraging the HOPES framework can help clients understand the benefits of strategic diversification.