Planning the pivot: from equity risk to portfolio balance

By Erik Berge | Senior Wealth Strategist, Citizens Private Wealth

Introduction

A concentrated stock position, typically defined as a single holding that makes up more than 10–20% of an investor’s overall portfolio, is often an unintended result of meaningful value creation. A concentrated stock position can arise through founding or building a high-growth company, holding a long-term outperformer or accumulating equity through executive compensation. For general partners in venture capital and private equity firms, carried interest that is paid out in low, or zero basis portfolio company stock can also lead to a concentrated position. In other cases, concentrated holdings may stem from inherited or gifted shares. While these positions can generate considerable wealth, the challenges related to diversification, liquidity and tax efficiency require thoughtful planning.

Understanding the risks

When a single stock represents a significant part of an investor's portfolio, it can amplify market volatility, company-specific risks and liquidity constraints, making it difficult to plan for future goals or respond to unexpected financial needs. Understanding the full scope of these risks can help investors make more informed decisions and preserve flexibility.

Portfolio volatility: When a single stock dominates a portfolio, it introduces two key vulnerabilities. Market risk refers to the potential for losses due to broader market movements, economic downturns, interest rate changes or geopolitical events that affect the entire market. Concentration risk compounds this exposure by tying a large portion of wealth to the fate of a single company or sector. Together, these risks can make it harder to plan for long-term goals or maintain financial stability during periods of uncertainty.

Liquidity constraints: Large positions can be hard to sell without affecting the stock's price, especially in thinly traded securities or during market stress, creating liquidity risk. For insiders or major shareholders, regulatory restrictions and market optics can further complicate the ability to liquidate a position. Selling low-basis shares can also trigger significant capital gains taxes, making tax risk another powerful deterrent to diversify. Without a plan to manage these risks, investors may delay diversification, leaving their wealth exposed.

Behavioral considerations: Psychological and emotional factors commonly play a role in the decision to retain concentrated positions. Behavioral biases, such as anchoring, familiarity bias and inertia can hinder rational decision-making. Investors may feel an attachment to a company they founded, worked for or supported early on. These emotional barriers can prevent timely diversification.

Strategies for concentrated stock

Managing the risks of a concentrated position often requires a layered approach that balances risk reduction with cost, complexity, and long-term financial goals. The key is to evaluate each option within the broader context of your financial picture and to partner with qualified advisors to ensure proper execution.

Gradual liquidation with tax planning: Selling shares over time can be an effective way to manage capital gains taxes by spreading them across multiple tax years. This approach enables investors to:

• Potentially take advantage of lower marginal tax brackets.
• Strategically offset gains with losses.
• Align sales with income fluctuations.

Additional execution strategies, including tax-loss harvesting (explored in our follow-up article) may provide ways to offset gains and improve after-tax outcomes. Emerging structures, such as long/short tax-loss harvesting strategies, may complement liquidation plans for investors seeking more flexibility. Investors should work closely with their tax advisor to ensure effective execution.

This strategy can be paired with ongoing gifts to family and, when deductions are available to offset the additional tax liability from sales, can also complement charitable giving strategies.

Charitable giving: Using concentrated stock to fulfill charitable goals can reduce portfolio risk while supporting philanthropic and legacy planning. For investors seeking tax efficiency, donating appreciated shares to a donor-advised fund (DAF) can eliminate capital gains taxes and provide a charitable deduction.

A Charitable Remainder Trust (CRT) offers another way to reduce taxes, generate income and diversify. By contributing appreciated stock to a CRT, the investor avoids immediate capital gains taxes and the trust reinvests the full proceeds into a diversified portfolio. The investor receives annual income for life or a set term, typically based on a fixed percentage of the trust's value. While taxes are deferred at the time of sale, a portion of the gains is gradually realized through income distributions. The investor also receives a partial charitable deduction based on the value of the remainder interest that will eventually pass to charity. At the end of the trust term, the remaining assets are donated to the designated charitable organization, which can include the investor's DAF. This strategy can help preserve more capital for income and diversification while supporting long-term philanthropic goals.

Advanced approaches may combine CRT funding with tax-loss harvesting strategies to further mitigate tax exposure over time, creating a layered solution for income and diversification.

Exchange funds: Exchange funds allow accredited investors to contribute concentrated stock positions in exchange for shares of a diversified portfolio, deferring capital gains taxes in the process. These private funds typically require a high minimum investment (often $500,000 or more) and a long-term commitment, usually a seven-year lock-up. To qualify for tax deferral under IRS rules, at least 20% of the fund's assets must be held in illiquid investments, such as real estate. Investors give up control of their original shares and, after the lock-up period, receive a diversified basket of securities. Taxes are deferred until those new securities are sold. Early redemption generally results in the return of the original stock and loss of tax benefits.

Prepaid variable forward contracts: A prepaid variable forward contract (PVFC) is a sophisticated strategy that allows investors with low-basis stock positions to access liquidity without triggering immediate capital gains taxes. In this arrangement, the investor receives an upfront cash payment, typically 75% to 90% of the stock's current value, in exchange for a future commitment to deliver a variable number of shares, usually within one to five years. The pledged shares serve as collateral, and the investor typically retains voting rights and dividends during the term.

The number of shares ultimately delivered depends on the stock's performance: fewer if the price rises above a cap and more if it falls below a floor, offering partial upside and some downside protection. The investor remains exposed to losses below the floor. Early unwinding from a PVFC can be costly, and regulatory scrutiny, especially for insiders, requires careful compliance. To preserve the intended tax treatment, proper structuring is essential, making experienced legal and tax guidance critical.

Hedging with options: Like PVFCs, options strategies can offer downside protection while preserving some upside potential. This makes them another tool for managing concentrated stock risk without triggering immediate taxes. However, managing the tax implications can be complex. Investors should consult with a certified public accountant or other qualified tax advisor to evaluate whether the potential benefits of trading options outweigh the costs, including contract premiums and tax consequences.

Common options strategies include:

• Protective puts, which limit downside risk while maintaining upside exposure.
• Covered calls, which generate income but cap gains above the strike price.
• Equity collars, which combine protective puts and covered calls to define a range of outcomes.

Final thoughts: turning concentration into opportunity

Concentrated stock positions can be both a source of great wealth and significant risk. There are a range of strategies that can help investors reduce risk, access liquidity and manage taxes. Proper execution of these strategies is key. With careful planning, a concentrated position can be transformed into a more balanced and flexible portfolio while preserving long-term value.