The Price of Holding On: Why Risk Management Matters for Your Portfolio by Zak Gardezy, CFP®
In the world of investing, there's one rule that should always remain at the forefront: manage your risk. This is especially important when analyzing your portfolio, yet many investors shy away from this essential step, fearing the specter of a hefty tax bill. However, managing risk does not always mean losing out financially—particularly if you have a strategic approach. Today, I’ll highlight how you can de-risk without triggering an overwhelming tax hit, but first, let me provide a perspective on the cost of ignoring risk management altogether.
Consider these once-titanic company names:
Lehman Brothers
Enron
Worldcom
Washington Mutual
General Motors (pre-bankruptcy)
Kodak
Blockbuster
Bear Stearns
Circuit City
RadioShack
Hertz
J.C. Penney
Neiman Marcus
GNC Holdings
Pier 1 Imports
Toys "R" Us
All of these companies shared a common denominator: for a time, they seemed too big to fail. They had competent managers, savvy senior executives, and well-compensated C-suites—all of whom believed in their companies and held significant wealth in company stock. Yet they fell victim to risk that went unheeded, and when these companies faced their downfalls, employees who held substantial portions of their wealth in these stocks lost everything.
Within these corporations were countless individuals—financial analysts, software engineers, sales managers, HR professionals, executives—whose livelihoods were intricately tied to their company's fate. Many were compensated through equity plans and stock options, believing this would lead to future prosperity. But when the market turned, when profits faltered, or when scandals broke, the value of their shares evaporated. They had an opportunity to diversify, to mitigate risk, and avoid the worst. Instead, they held on—trying to avoid a tax bill—only to see their savings and investments decimated.
The lesson here is clear: don’t fall into the same trap. We naturally feel an affinity for the companies we work for. We believe in our work, we trust in the business model, and we have confidence in the future. But this optimism can often cloud our judgment, leading us to disregard risk and hold on longer than we should. The result? Our "risk goggles" get turned off.
This doesn’t mean you shouldn’t own any employer stock. In fact, for those in the growth or aggressive growth phases of wealth building, there’s a case for holding a larger portion of your employer’s stock. But as your wealth grows and that company stock becomes a significant share of your portfolio, it’s time to reevaluate.
So, when should you diversify? Clients often ask me for a specific percentage—how much is too much to have tied up in company stock? The truth is, there is no magic number. The answer depends on many factors: your stage of life, your risk appetite, the financial outlook of your company, and the broader market landscape.
Consider a few examples. If you’re an employee at Nvidia right now, things probably look promising; the company’s future seems bright. But what if you’re at Super Micro Computer, dealing with legal headwinds and thinning margins? You may wish you had diversified months ago. Or consider Intel employees who have seen their company’s stock slide over the past five years, while competitors like Nvidia and Broadcom have soared. The same holds true for Boeing employees who held on through turbulence, hoping for a rebound, while other aerospace companies flourished in the interim.
The key is to act before it’s too late. Working with a financial planner can help you take a holistic view of your financial picture. By understanding your goals, your stage in life, and how your company stock fits into your broader financial landscape—including taxes, estate planning, and retirement accounts—you can make informed decisions. A well-rounded plan can help you diversify your holdings in a manner that’s thoughtful, minimizing tax consequences while managing risk effectively.
Risk waits for no one. A financial planner can guide you through the process of de-risking—whether it means selling shares all at once or in increments, with strategies tailored to your tax situation and risk profile. Don't let pride in your company blind you to the need for balance in your portfolio. The goal is not just to grow wealth, but to protect it.
3 Ways To Reduce Risk While Being Conscious of Taxes
1. Sell Over Time, with a Plan Consider selling shares over a number of years, with a goal of selling a set percentage of shares annually. By spreading your sales out over multiple years, you’re also spreading out your tax liability, which gives your assets time to grow and compound while reducing risk incrementally. Remember, selling shares doesn’t mean you must stay out of the stock market. You could reinvest the proceeds in a basket of your company’s competitors if you feel optimistic about the industry, or you could diversify more broadly by investing in a low-cost passive index ETF. The key is to reduce your risk by diversifying while managing the tax implications thoughtfully.
2. Use Options to Hedge Options allow you to create hedging strategies that protect your portfolio. You could learn to trade options yourself, or work with a financial advisor, portfolio manager, or options specialist. Personally, even with my background, I understand that managing options portfolios can be complex, which is why I often partner with leading options managers to handle this for my clients. By paying a nominal fee, clients gain peace of mind knowing that a professional options trading team is protecting their investments. You don’t have to hedge all your shares; you could start with, say, 25% of your position while leaving the rest unhedged. However, one important caveat: if you are currently employed by the company that issued your shares, your employer may have policies restricting the use of options to hedge. Always be mindful of compliance—losing your job is not an effective risk management strategy!
3. Use Exchange Funds or Exchange Fund Replication Strategies At Wealthstone, we provide our clients access to Exchange Funds and Exchange Fund Replication Strategies. An Exchange Fund is an investment strategy where you "exchange" your company shares with an asset manager—such as Goldman Sachs—and in return, receive a diversified basket of stocks, often mirroring an index like the S&P 500, plus a 20% real estate allocation (as required by IRS rules). Because this is an exchange, rather than a sale, there is no immediate tax liability. You effectively eliminate the risk of holding concentrated company stock and diversify your risk across the broader market and real estate.
A better option, in my opinion, is an Exchange Fund Replication Strategy. Using options, traders replicate the risk and return profile of holding an S&P 500 index fund while eliminating the specific risk of holding concentrated stock. This strategy can be more flexible and often involves lower fees. Unlike traditional exchange funds, you’re not required to allocate 20% of your portfolio to real estate, and you’re not subject to holding period restrictions. Plus, these replication strategies are available to more investors, with fewer restrictions on minimum net worth.
Between these strategies, investors can diversify their risk either immediately or within a few months (Exchange Funds often take time to set up, whereas Replication Strategies can be implemented quickly). It’s important to remember that these strategies do not eliminate capital gains taxes; they simply allow you to diversify without triggering a tax liability upfront.
If you or someone you know holds a significant amount of company stock or has multiple concentrated stock positions and wants to learn more about diversifying efficiently while managing taxes and fees, I encourage you to reach out. I would be happy to provide a no-cost analysis and consultation, whether over Zoom or by phone.
Don’t let risk or fear of taxes take control of your financial future—take steps today to protect what you’ve worked so hard to build.
Zak Gardezy, CFP®
Founder & Private Wealth Advisor Click Here To Watch "Money Minutes" - Weekly Market Update YouTube Series
Wealthstone Private Wealth Management
7014 E. Camelback Rd. Suite B100A
Scottsdale, AZ 85251
Email: zak@wealthstonepwm.com
Mobile: (480) 973-3560
Website: Wealthstone Private Wealth Management (wealthstonepwm.com)
