1. What Is Concentrated Stock and How Does It Come About?
“Concentrated Stock” refers to a situation in which a large portion of a household’s investable assets is concentrated in one or just a few stocks. Many textbooks suggest that if any single stock makes up more than 15% of your liquid net worth, it can be considered “concentrated.” However, that specific threshold can vary from person to person, depending on individual financial circumstances and risk tolerance.
In our practical experience, clients in Silicon Valley’s tech sector tend to be relatively “unfazed” by concentrated holdings. For example, we once encountered a young engineer client in his late twenties—unmarried, no children, low living expenses—who had 90% of his liquid assets in a single tech giant where he is working. We asked him, “How would you feel if that stock’s price got cut in half?” He firmly replied, “No problem. Worst case, I can just start over and find another tech job.” In his situation, a high level of concentration is not necessarily a bad thing, as he is young, capable of restarting if needed, and believes he can psychologically handle large market swings.
But if you are late in your career or close to retirement—perhaps with family obligations, a mortgage, car loans, etc.—you should be more cautious about concentration. We have seen clients in their fifties or sixties with half their assets in the stock of a single company. That might not seem problematic in a strong market, but if the sector hits a downturn, the losses can be substantial.
Naturally, concentrated stock has also made many people wealthy. When a company goes public or its share price soars, employees who went “all in” on that one stock can become millionaires overnight. Because of this, some younger clients still insist, “I want to concentrate on a single stock to maximize returns.” It’s a personal choice, but the risk is significant. If you want to “strike it rich,” you must be prepared for large swings; if you want to be more “stable,” you need to consider diversification.
2. What Problems Can Concentrated Stock Cause?
Risk
The first major concern with concentrated holdings is heightened risk.
Let’s talk about risk first. We work with many clients from major tech companies on their financial planning. One question I often ask them is this:
“If your company handed you $100,000 in cash today, would you immediately turn around and invest all of it in your employer’s stock?”
So far, I’ve met only one client—a 27-year-old engineer—who answered “yes.” For 99% of people, the rational answer is “no.” Why? Because you already rely on that same company for your salary and career prospects, so putting all your money into its stock obviously magnifies your risk. If something goes wrong with either the company or its industry, you’d face a double hit: potential job loss and a drop in your investment’s value.
However, in practice, most big tech employees are effectively “all in.” Here’s why: once your RSUs vest, they’re identical to cash from a tax perspective—you’ve already paid taxes through your W-2. If you do nothing (i.e., you don’t sell and diversify), it’s as if you took your $100,000 in cash and bought your company’s stock all over again. In other words, by keeping vested RSUs without selling, you’re making a de facto decision to be “all in” on your employer.
Taxes
Another common issue is taxation. In California, for instance, if you combine the federal long-term capital gains tax rate with the state income tax, the total can reach around 37.1% (23.8% at the federal level plus 13.3% for California).
Many people say, “Then I just won’t sell—no sale, no capital gains!” Indeed, if you never sell, you won’t realize any gains, and thus no capital gains tax is due.
The problem arises if you decide you need to reduce risk—perhaps by liquidating some of your shares or diversifying. In that case, you’ll generate realized gains, which come with a tax bill.
Balancing the desire to reduce concentration against the associated tax liabilities are a primary reason many clients seek our advice.
3. How Can You Reduce Taxes While Controlling Risk?
Below are several effective approaches. In our years of providing financial planning services, we’ve seen many clients employ these strategies to resolve the “to sell or not to sell” dilemma.
Direct Indexing
This approach has become popular in recent years, enabled by advances in trading technology.
By holding a basket of stocks that closely mirrors an index (like the S&P 500), you can achieve similar returns to the index.
The biggest advantage is the ability to do Tax Loss Harvesting in real time. For instance, if Coca-Cola is down, you can sell it and buy Pepsi instead, locking in the loss (which can offset other capital gains later) while maintaining exposure to that sector.
One drawback: if the overall market rises, you won’t get much loss to harvest. Additionally, you need some cash or must sell part of your concentrated holdings to purchase the index basket.
Exchange Fund—A More Flexible Way to Diversify Concentrated Stock
a. Basic Mechanism of an Exchange Fund
Converting a Single Stock into Fund Shares
Suppose you hold a significant amount of Microsoft shares with large gains. Selling them outright would cause large capital gains taxes. Instead, you can place them into a specialized Exchange Fund and receive a proportional share of that fund.
Benchmarking Major Indexes
Often, the fund tracks major indexes like the S&P 500 or Russell 3000 and may hold companies from various industries. Thus, your assets move from “betting on Microsoft alone” to a basket of stocks, while deferring immediate capital gains tax.
b. The 7-Year Lock-Up and Redemption
Typical Rule: Hold for 7 Years
Many Exchange Funds require that you hold your shares for at least seven years. During this period, you benefit from the fund’s diversification, but you cannot freely redeem your shares.
Redeeming a Basket of Stocks
After the required holding period, you can choose to redeem. What you receive won’t be your original Microsoft shares but rather a basket of stocks (often the fund’s core holdings). Since this is structured as a “swap,” from a tax standpoint, it’s generally treated as a deferred event rather than an immediate taxable sale.
c. Integration with Estate Planning
Step Up in Basis under U.S. Tax Law
If you pass away while holding Exchange Fund shares, your heirs can benefit from a “step up in basis.” This means the cost basis for those shares (or the shares you receive upon redemption) is recalculated at the market value at the time of inheritance. Therefore, if you initially held stock that appreciated dramatically (from a few dollars to hundreds per share), selling it outright would normally trigger substantial capital gains. But by placing it into an Exchange Fund and incorporating estate planning, your heirs could establish a new cost basis at the prevailing market value, thereby substantially reducing or even eliminating the original gains’ tax liability.
d. Why Is It Suitable for Certain People?
Avoiding Immediate Large Tax Bills
If your single stock has risen multiple times in value, selling it outright could generate a hefty capital gains tax. An Exchange Fund offers a “buffer,” allowing you to diversify first without immediate taxation.
Achieving Diversification
By contributing shares to the fund, you spread your investment across various industries and companies, minimizing the risk of extreme volatility from holding just one stock.
A Medium- to Long-Term Investment Horizon
The 7-year lock-up means you can’t do frequent short-term trading, so this suits those who planned to hold long-term anyway and want to reduce risk over time.
Estate Planning Benefits
For some, wealth management isn’t only about their own lifetime but also about legacy planning. An Exchange Fund combined with estate strategies can significantly reduce potential inheritance-related capital gains taxes.
Charitable Remainder Trust (CRT)
This is a tool combining charitable trusts with deferred taxation.
You can transfer your stock into a charitable trust, which can then sell the stock without incurring immediate capital gains taxes. Afterward, over a specified time frame (e.g., 10 or 20 years), the trust pays you a certain percentage of the assets, and you only pay taxes as you receive each distribution.
Once the trust terminates, any remaining assets are donated to a charitable organization. This strategy is especially appealing for those with strong philanthropic inclinations or for those expecting a lower tax rate in certain future years. It also allows you to fulfill charitable goals while enjoying some tax advantages.
Conclusion
In our work providing financial planning to clients of various ages and life stages, we’ve observed that concentrated stock is a “double-edged sword.” It might make you wealthy very quickly, but it can also expose you to significant risk.
If you’re young and can withstand volatility, you might seize higher short-term returns.
If you’re middle-aged or close to retirement and can’t afford a major drop in your portfolio, you should plan early, diversify, and structure your taxes strategically.
Ready to Take the Next Step?
If you’re concerned about concentrated stock risk, tax implications, or simply want to explore personalized financial planning strategies, we’d be happy to help.
Schedule a free 15-minute conversation with ushttps://go.oncehub.com/Taurus to discuss your unique situation and see how we can support your financial goals.
Disclosure:
This material is for general information only and is not intended to provide specific advice or recommendations for any individual. No strategy assures success or protects against loss. This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk. 4. Please add the following information or add it as a disclosure: ETFs trade like stocks, are subject to investment risk, fluctuate in market value, and may trade at prices above or below the ETF's net asset value (NAV). Upon redemption, the value of fund shares may be worth more or less than their original cost. ETFs carry additional risks such as not being diversified, possible trading halts, and index tracking errors.