Help­ing Clients Let Go

What­ever the rea­son, it’s al­most al­ways prob­lem­atic when a client holds on to a very large po­si­tion in one stock.

Financial Planning - - CONTENT - By Don­ald Jay Korn

What­ever the rea­son, it’s usu­ally prob­lem­atic when a client holds on to a very large po­si­tion in one stock.

A TIME-HON­ORED ID­IOM WARNS AGAINST PUTTING all your eggs in one bas­ket (or even too many eggs!). The rea­son is ev­i­dent to every ad­vi­sor: Such a port­fo­lio is vul­ner­a­ble to be­ing cracked or bro­ken if a sin­gle stock slips.

Even the heart­break­ing sto­ries of in­vestors who lost most of their wealth af­ter En­ron and Lehman Broth­ers col­lapsed can’t per­suade some clients to sell.

“With­out ques­tion, clients with con­cen­trated port­fo­lios un­der­es­ti­mate the risks of own­ing a large po­si­tion in one stock,” says Paul Ben­nett, a man­ag­ing di­rec­tor of United Cap­i­tal, a fi­nan­cial life man­age­ment firm in Great Falls, Vir­ginia. “Clients should con­sider di­ver­si­fy­ing away from any po­si­tion that goes north of 5% to 10% of their over­all port­fo­lio.”

How can ad­vi­sors raise aware­ness of the pos­si­ble per­ils? One ap­proach is to use scare tac­tics. “When dis­cussing the down­side risk of a con­cen­trated po­si­tion,” says Lu­cas Bucl, a prin­ci­pal at KHC Wealth Man­age­ment in Over­land Park, Kansas, “we of­ten will cite ex­am­ples where a large loss of value has oc­curred with an­other stock. Some com­mon ones are En­ron, World­com, Sprint, AIG, Lehman Broth­ers or Chipo­tle.”

HOLD­ING PAT­TERNS

Large con­cen­trated po­si­tions can oc­cur if a client ac­cu­mu­lates shares of a pub­licly held com­pany for which he or she works. Ben­nett notes that hold­ings may re­sult from stock op­tions, per­for­mance shares, re­stricted stock units or par­tic­i­pa­tion in an em­ployee stock pur­chase plan. “There could be an al­lo­ca­tion to com­pany shares within a 401(k) or de­ferred com­pen­sa­tion plan,” he adds.

“In all of these cases, over­con­fi­dence bias can oc­cur: Clients feel they have a knowl­edge ad­van­tage be­cause they work for the com­pany,” Ben­nett says.” Un­for­tu­nately, this is usu­ally not the case. The lack of di­ver­si­fi­ca­tion can (and of­ten does) wreak havoc on re­tire­ment plan­ning.”

Other sources of con­cen­trated port­fo­lios can lead to

“In most cases, sell­ing pe­ri­od­i­cally or mak­ing char­i­ta­ble do­na­tions make the most sense,” says Adam Fuller, a prin­ci­pal at Hom­rich Berg.

what Ben­nett terms en­dow­ment bias. “A client may have in­her­ited a large po­si­tion in one com­pany from a par­ent or other rel­a­tive who had dili­gently in­vested for decades,” he says. “These clients may not want to sell the stock be­cause they be­lieve that would be go­ing against the wishes of their bene­fac­tor. Even think­ing about sell­ing stock that Un­cle Bill willed to them can pro­duce feel­ings of guilt.”

To over­come such in­sis­tence on stand­ing pat, plan­ners can point out the dan­gers. “What I’ve found to be most ef­fec­tive,” Ben­nett says, “is pro­vid­ing ex­am­ples of other (un­named) clients who did not di­ver­sify and were forced to mod­ify their re­tire­ment plan­ning. That meant work-

ing longer, hav­ing a lower in­come or other trade-offs.”

An­other op­tion, Ben­nett goes on, “is to dy­nam­i­cally show clients what-if sce­nar­ios on the screen. The client pro­vides fore­cast num­bers (good and bad) for the price of the con­cen­trated po­si­tion to see how volatil­ity im­pacts their over­all plan­ning. This ex­er­cise can be a re­al­ity check for many.”

EX­EC­U­TIVE DE­CI­SIONS

Per­suad­ing the client that a con­cen­trated po­si­tion is risky may be only part of the ad­vi­sor’s task. Un­for­tu­nately, some clients be­lieve ca­reer suc­cess is linked to hold­ing those cen­ter­piece se­cu­ri­ties.

“Many of our ex­ec­u­tive clients have ex­plicit or im­plicit hold­ing re­quire­ments for com­pany stock, which can be an im­ped­i­ment to man­ag­ing the over­all ex­po­sure,” Bucl says. “Of­ten, these clients must get man­age­ment ap­proval to sell po­si­tions. A re­quest to sell can be seen in a neg­a­tive light, im­ply­ing that the per­son sell­ing may not be 100% be­hind man­age­ment’s ini­tia­tives. We pre­pare our clients for these some­times un­com­fort­able con­ver­sa­tions by help­ing them ex­plain the strat­egy and rea­son­ing for want­ing to re­duce their stock po­si­tion.”

As Bucl ex­plains, the process for sell­ing com­pany shares may in­volve a for­mal re­quest, which goes through the firm’s HR de­part­ment to the com­pany’s gen­eral coun­sel or even to the fi­nan­cial chief for ap­proval or de­nial.

“For ex­am­ple,” he says, “I have a client who is an ex­ec­u­tive at a pub­lic com­pany. There are no spe­cific hold­ing re­quire­ments for him, but the cor­po­rate cul­ture looks down upon sell­ing its stock. It wasn’t un­til the stock had moved up and a few key ex­ec­u­tives sold some shares be­fore my client was even will­ing to en­ter­tain the idea of re­quest­ing per­mis­sion to sell.” The ex­ec­u­tive was still very re­luc­tant to raise the sub­ject, as he was up for a pro­mo­tion.

“We helped him fo­cus on some im­por­tant goals that he planned to fund with the stock sale pro­ceeds,” Bucl says. “The money would be used pri­mar­ily for col­lege costs and clean­ing up debt. We coached him so that he could ex­plain how the pro­ceeds would be used in his fi­nan­cial plan, when he was asked by a su­pe­rior.

“As a re­sult, he got the green light to sell the stock and still re­ceived the pro­mo­tion a few months later,” he adds.

MAK­ING IT HAP­PEN

If the client (and per­haps the em­ployer) agrees, plan­ners can ini­ti­ate tac­tics to move money from the sin­gle stock po­si­tion.

“In most cases, sell­ing pe­ri­od­i­cally or mak­ing char­i­ta­ble do­na­tions make the most sense,” says Adam Fuller, a prin­ci­pal at Hom­rich Berg, a wealth man­age­ment firm in At­lanta. Sell­ing ap­pre­ci­ated shares in a tax­able ac­count may gen­er­ate tax bills, but the low tax rates on cap­i­tal gains and the pos­si­bil­ity of off­set­ting cap­i­tal losses may keep that pain man­age­able.

Do­nat­ing ap­pre­ci­ated shares will avoid taxes. “Low-ba­sis con­cen­trated stock is a won­der­ful as­set to use to fund char­i­ta­ble gifts,” Fuller says. “In the right sit­u­a­tion, us­ing a large gift to a donor-ad­vised fund or a pri­vate foun­da­tion to cre­ate a pool for fu­ture gifts can be an ex­cel­lent strat­egy if the client is char­i­ta­bly in­clined. It is amaz­ing how many clients are sur­prised when we ex­plain

“Clients should con­sider di­ver­si­fy­ing away from any po­si­tion that goes north of 5% to 10% of their over­all port­fo­lio,” says Paul Ben­nett of United Cap­i­tal.

this op­tion; as plan­ners we of­ten for­get that what is com­mon knowl­edge to us is a great in­sight to fam­i­lies.”

Af­ter learn­ing of the ben­e­fits, many clients with con­cen­trated po­si­tions start do­nat­ing stock in­stead of cash, ac­cord­ing to Fuller. “One client, for ex­am­ple, has a very high an­nual in­come and tithes se­ri­ously,” he says, “re­sult­ing in sub­stan­tial an­nual do­na­tions to his church. He had no idea that he could do­nate stock in­stead of cash; he was sit­ting on some le­gacy stock po­si­tions from his old em­ployer that he did not want to sell due to taxes. Those shares could be used to fund the DAF.”

Fuller adds that one way to deal with con­cen­trated po­si­tions is to re­mind clients that ac­quir­ing wealth and pre­serv­ing it are two dif­fer­ent skill sets.

“We stress the idea that ac­quir­ing sig­nif­i­cant wealth is of­ten the re­sult of con­cen­trat­ing ef­fort in a sin­gle firm,” he says. “Pre­serv­ing that wealth is an equally im­por­tant but

Af­ter learn­ing that do­nat­ing ap­pre­ci­ated shares will help avoid taxes, many clients with con­cen­trated po­si­tions start do­nat­ing stock in­stead of cash, says Adam Fuller of Hom­rich Berg.

dif­fer­ent task. As we tell those clients, you won the race by be­ing con­cen­trated, but you keep the tro­phy by be­ing di­ver­si­fied. There is no rea­son to keep us­ing a high-risk strat­egy of a large con­cen­trated po­si­tion once you have al­ready won.”

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