Jamie: Holding onto a single winning stock can build incredible wealth, but it can also leave your entire financial future hanging on the fate of one company. It's one of the most rewarding yet tricky dilemmas in wealth planning: what to do when a concentrated stock position begins to dominate your portfolio.
Whether you built your position through equity compensation or early startup investment, or decades of long-term growth, deciding when and how to diversify comes with big questions around risk, taxes, and timing. This is a special episode of What Should I Do With My Money?, an original podcast from Morgan Stanley.
I'm Jamie Roô, and the topic of how to manage a concentrated stock position has come up twice this season already. So today, we'll get into the ways we can help our clients navigate this increasingly common situation for a lot of people. To do that, I'm joined by two colleagues with specialized expertise in this area: Meghan Mahoney, head of our Concentrated Equity Specialist team, as well as Steve Edwards, our head of Portfolio Construction and Cross-Asset Strategies for Morgan Stanley Wealth Management.
So, let's dive in. Meghan, let's start by defining what we mean by concentration.
Meghan: So, by definition, a concentrated stock is a single stock position that represents a significant percentage of your overall total net worth. I've seen it defined anywhere between, let's call it 15 to 20%, but in reality, it means different things to different investors. So that's really what we want to address and work to right-size that weighting, while also taking into account your personal circumstances. It's really a human challenge as much as it's a financial challenge.
Jamie: And what are some of the most common ways you see clients ending up in this situation with a concentrated position?
Meghan: So, I think you, you touched on a couple of them just in the kickoff, right? I see concentration arise most commonly through the workplace, so employment, or a great investment that's been a winner and concentrated over time. Inheritance, gifts passed down from generations. And again, you touched on this as well, more relevant right now is some of these early investors, pre-IPO investments that I would describe as pending concentration.
Jamie: And so, what is it that typically triggers a conversation with you and your team? What are some of the catalysts that make people say, "Oh, shoot. I need to take a look at this"?
Meghan: “Oh, shoot.” It's rarely one trigger and-- and more often it's gonna be a combination of life and market happens. Everyone's situation and their journey is gonna look different. Uh, often it really comes to life during a financial planning or an estate planning conversation. Other times, it's triggered by market volatility, upcoming retirement, maybe the sale of a business or pending liquidity event, like an IPO as, as we talked about. So, bottom line is that those moments tend to lead people to ask, "Am I being thoughtful about this position, or am I just continuing to hold it because I always have?"
Jamie: And just to level set, at the risk of stating the obvious here, Steve, explain to us why holding one stock can create so much risk, especially if it's been such a great performer for people over time.
Steve: Sure, Jamie. Great, great question. Where that's coming from is really what we like to call volatility share, or how much of your risk is coming from that specific position. And the reality is that even holding a 20 or 30% position could mean that that stock is contributing more than 50 percent and maybe up to 80 or 90 percent or more of the risk in your portfolio. And the reason for that is each single stock typically has greater volatility than a diversified portfolio or even the equity index. We find that many stocks have double or triple or even quadruple the amount of risk of, let's say, the S&P 500. And so, as a result, that volatility translates into big swings in your portfolio, and it's very, very challenging to take any action outside of that specific concentrated stock that would help you to diversify meaningfully. That is to say, if you have an eighty percent position in a concentrated stock, that other twenty percent is very difficult to allocate in any way that would make a big difference for your portfolio, leaving you very much exposed to the ups and downs of that specific stock.
Jamie: Meghan, what are some of the most common reasons people hesitate to diversify in your experience?
Meghan: Sure. The biggest obstacle is usually the stock's been a winner, so it's, it's easy to understand why someone wouldn't wanna change course when an investment has created so much wealth. It's funded your home, it's funded your lifestyle, it's funded your child's education. So, why change something that's worked so well? And markets have typically gone up. And then, you throw in other factors like loyalty and taxes. In some case, there's a deep and long-standing connection to the stock. Maybe you work for that company, you helped shape the strategic vision. As we touched on earlier, you inherited that company maybe from a parent or, or grandparent. And then, taxes are another big one. Large embedded gains and worry about writing that check to Uncle Sam. Uh, and then of course, FOMO, fear of missing out. It's hard to imagine selling something that's consistently gone up, and then only to see it continue to climb. So, I think it's really important to acknowledge and respect all of those reasons. My job is not to convince you that holding's the wrong decision, and we're not there to tell you what you should do with a stock that you've owned for many years. But, we can help educate on the solutions in the toolkit and the different considerations and trade-offs.
Jamie: So, now that we understand the various ways a client might find themselves holding a concentrated position, the risks inherent in that, and why it can be potentially challenging to unwind, let's talk about some of the strategies available to manage concentration. So, Steve, at the highest level, walk us through the framework that you use to approach this with clients.
Steve: We call it the HOPES framework. It stands for-- it's an acronym. We love acronyms here. Hold, Options, Planned giving, Exchange funds, and Sell. We'll go through what those different, uh, letters mean and the different strategies. But overall, you can see that it involves multiple strategies, right, uh, that have multiple goals beneath them. And what we're really trying to do with that framework is to match investors' goals for the future, which might include diversification income, charitable giving, tax mitigation, uh, trying to match their goals for the future with the strategies that carry out those different goals. And so we believe that from all the work that we've done, that taking those strategies together makes the whole better than the sum of the parts. And so, ultimately, it's very difficult to disentangle a concentrated equity position with any single strategy. But with the HOPES framework, we think that we can bring, sorry for the pun, hope to a situation that is risky, uh, and ultimately help a client to achieve multiple goals at the same time in a straight-line and streamlined way, that ultimately leads them to their best interest. The great thing about the framework, which we'll get into a little later, is that you can run some math and calculations on that framework to think about what a client's specific approach would be. But, at the end of the day, it's about multi-strategy, diversification, and goals-based focus.
Jamie: And we definitely want to get into the tools and analytics that help power this type of framework. But, for now, let's unpack it a little more and maybe bring it to life a bit. Meghan, the H stands for hold. So, when would holding be a deliberate decision, not just the product of inertia? What would be some scenario where somebody might just decide to hold, and what else should be, they should be thinking about with a decision like that?
Meghan: Right. I think oftentimes the instinct is how much am I holding or, or how much should I sell? And, in reality, it's usually the wrong question, because it's rarely an all or nothing. So, I typically ask a different question. If you were handed the value of your position in cash today, would you put 100% of it back into that one stock? And for most, the answer is probably not. And that's where it becomes more about sizing the position. Holding's now a strategy because it's a choice, it's more deliberate, and we start to really define that hold bucket. Now that we've defined it, the conversation becomes much more productive, because we can now begin to think about what role the remaining portion in the position should play. And I think Steve started to get into this. What are we trying to achieve here? Is it diversification? Do we need liquidity? Are there charitable inclinations? Are there tax considerations? Yes, there are always tax considerations. What does maintaining exposure look like, and do we wanna protect against a downside? So, as Steve mentioned, enter the framework that we call HOPES, which helps organize the different tools and strategies available. So, tailor a game plan that's right for you.
Jamie: So, let's move through the framework a little bit. So H in HOPE stands for hold, which Meghan just covered. O stands for options. So Steve, what sorts of needs can an options-based approach help address, whether that's related to risk, volatility, income perhaps, and what are the trade-offs there?
Steve: I think the important thing to see here is that we're going to be talking about the O, the P, and the E. I like to think of them as forging a middle ground between holding and selling. And Meghan set it up very well that many clients are kind of wrestling with hold versus sell, and we'd like to basically introduce these, uh, additional strategies. With that in mind, I would say options are a key part of the playbook. Not necessarily in every situation are they applicable, but, what they can do, is help to mitigate downside risk, potentially create some income, potentially create a forward monetization, which allows us to, basically take our stock position and reshape the future distributions to be different with-- than what they were before. And typically, these option strategies are not a one and done type thing. This is typically something we might carry out over time. And so, many clients will kind of consistently move forward with options. But ultimately, they can be used in concert with other strategies. And one of the biggest things I would just say here is that, you know, options generally are going to be, let's call it, five to th, thirty-five percent of the solution. Any one of these solutions, they may sound great on their own, but generally, we find that that's only making a part of the potential solution. And so, in general, we think that, you know, this is a mitigant, and can help really on income, volatility reduction, or diversification, depending on the strategy.
Meghan: And you can think of it like insurance. You buy insurance not because you expect something bad to happen, but you want the protection in case it does. So, I think the punchline is there are a lot of options for options, and sometimes they trigger complexity, but obviously that's why we've got a team and resources to help, sort of, demystify.
Jamie: Okay, let's move on to the P, and we'll get through some of these middle strategies between the H and the S. Between the hold and the sell, we have this middle ground. Covered options, now the P. Meghan, so, P stands for planned giving, correct?
Meghan: Yup, you got it.
Jamie: Explain what that, what that means for a client.
Meghan: Sure. Planned giving's an interesting one because it sits at the intersection of so many of the themes we're talking about today: philanthropy, taxes, diversification. And many people support charities by simply writing a check, donating with dollars. But, if you own a highly appreciated concentrated stock, you probably have another asset available to accomplish that same giving goal. For example, shares can potentially be donated to what we call a donor-advised fund. That gives you the flexibility to support charities over time, while also receiving the benefit of a full charitable deduction without realizing the gain. For investors who want income, there are certain strategies that can potentially turn that appreciated stock into both a charitable gift as well as an income stream. These are called split-interest charitable vehicles, and you can ask your advisor to learn more about that. So, planned giving really reframes the concentrated conversation. That asset that created both the opportunity and the challenge is now part of the solution, and potentially, it's become one of the most impactful assets that you own.
Jamie: Moving through to E, exchange funds. Meghan, at a high level, 'cause I know this is a complicated topic as well, what is an exchange fund, and what problem does it solve for clients?
Meghan: So, you can think of an exchange fund, and I may have stolen this one from Steve, but I like the analogy, that you can think of an exchange fund as a stock swap club, where everyone brings their concentrated positions to the party. So, Jamie's gonna bring a healthcare stock. Steve's gonna bring a tech company. We all put it in a basket, and seven-plus years later, we leave with a diversified portfolio instead of the single concentrated stock that we arrived at the party with. And so these are private funds for qualified purchasers. So typically, an individual who owns at least 5 million or more in investments and excludes your primary residence. So, for investors who are looking for diversification and risk reduction, but they're not quite ready to write that check to Uncle Sam. So, these investors would contribute into these pooled private funds alongside other investors. The fund portfolio manager is now gonna own a basket of stock that they will accept and reject these stocks according to the benchmark that they're intended to follow. And so, exchange funds really help solve one of the biggest dilemmas in the concentrated equity conversation, which is, I know I need to diversify, I'm on board, but I don't, I don't wanna be hit with an immediate tax bill.
Jamie: And that actually brings us to the S in HOPES for selling. So Meghan, what are the considerations, including taxes, that someone needs to think about when it's time to sell?
Meghan: The challenge with selling a concentrated stock is that selling realizes the gain, and that can create a tax bill. So, rather than viewing selling as an all or nothing, we can be much more thoughtful about how you sell. You might choose to pace sales over time and coordinate them with losses elsewhere in your portfolio. If you can harvest those losses, they may help offset some of the gains you're realizing as you reduce that concentrated stock position. You've probably heard of direct indexing, which has been around for over 25 years. That's about mirroring an index while actively tax loss harvesting, again, generating losses that can help soften your future tax bill. More recently, there's been a lot of buzz and attention around tax-aware long-short strategies. What changes here is that instead of simply mirroring an index and actively tax loss harvesting, the manager is now targeting pre-tax returns. They are looking to beat an index, and they've also relaxed the long-only constraint, now introducing leverage, so additional long exposure as well as short exposure. So these strategies offer greater customization and can be extremely attractive for the right use case. They're also sophisticated, making manager selection and a clear understanding of the strategy step one. With all of these strategies, I, I like to think of taxes as a toll. The goal isn't necessarily to avoid the toll forever. We wanna be thoughtful about when you pay it, how much you pay, and what you're getting in return. So ultimately, direct indexing, long-short, all of what we've spoken about, can help selling less about ripping the Band-Aid and more about how do we create a thoughtful path from concentration to diversification.
Jamie: And so, we have this framework that you just described for different ways to address all these goals and risks. Steve, how do our advisors and specialists help people think through which combination of solutions is right for them? What types of tools and analytics come into play?
Steve: Sure, Jamie. So we've developed a set of tools that I think can help us to look both at what makes a stock vulnerable, and then how can these concentrated equity solutions work together in that HOPES framework. So, what we've determined is that certain stocks have certain characteristics that would make them more susceptible to what we call drawdowns. That's when a stock falls from its high water mark or its high, you know, price level to a lower price level. And we found that there's ways of identifying those stocks that are more likely to be susceptible to that. And it's not just volatility, but there are other factors that we can look towards, including financial stability or instability, and then whether the fundamentals of that company are improving or worsening. So, that's one of the things that we try to bring to the table. That's a stock-level analysis. But then, looking at the client's situation holistically, again, what we're trying to do is to take the client's goals, the client's tax situation, the client's situation with the specific stocks, what the rest of their portfolio looks like, their ages, and pull this all together into some sort of fulsome plan. And that plan would likely include multiple of the HOPES strategies, but in general, you have to take those strategies holistically and see how they would interact with one another. I like to think about the HOPES strategies a lot like building an asset allocation for someone, right? So, the different strategies have their own asset allocation-like characteristics, their tax characteristics, and income characteristics. And so, we can take all of those things together and build a holistic approach. So, that's where we've developed this HOPES for concentrated equity tool for addressing that.
Jamie: Can you take us under the hood of the tool a little bit? Just describe, like, when you're having these conversations with clients, what are the inputs that you're looking for that get put into the tool?
Steve: Our goal with the tool is ultimately to help to see, given certain levels of inputs, and those inputs would be most importantly, what stock do you own, right? What are the tax lots like? What are your strategies that you're open to considering as a client? What are your goals as a client? And what are the ages of potential income beneficiaries off of any charitable strategies that would be income-producing? And so, taking that information, we're effectively trying to come up with what would be the best strategy from a probability of success, uh, when you're approaching the HOPES strategies. And so, think about it as we're trying to solve for the pie chart. If you think about a pie chart, when you first come in with a concentrated stock position, your pie chart is a hundred percent H. But from that point, you're going to need to basically make some sort of, tilt or-- or movement to think about what that pie chart should look like in the future. And so, um, as we've discussed the hundred percent H scenario has its risks, and particularly related to drawdowns. But if we could take that a hundred percent H and maybe make it forty percent H, and now we have sixty percent to O, P, E, and S, now we're starting to introduce some flexibility, and that flexibility is going to help us to, kind of, reshape our asset allocation and reshape our portfolio towards the goals that matter to the client as of that time. And that's really something that's very helpful to see, is that you're typically restricting or narrowing your range of outcomes with HOPES versus holding. You have a very wide range of outcomes. You can have some really great outcomes and some really not so great outcomes. What HOPES generally is about doing is trying to preserve good outcomes, or reducing the probability of those terrible outcomes. And I like to say, and Meghan would definitely agree, what people do with their concentrated stock is their most important financial decision for many people. And so, we wanna be there to help them. Ultimately, this is such an important decision, particularly for folks maybe who have just retired from a, a company and have a lot of wealth in that name. Their future really will be determined by that decision. And, and we would love for folks to have a tax sensitive, risk sensitive approach to that, that, that leads to their ultimate financial goals.
Jamie: Okay, we've covered how this all works in theory and the model of how we put these portfolios together for clients. In, in practice, Meghan, what are the rules of the road people should understand, in terms of eligibility requirements, a certain issue or affiliation that may determine which of these particular types of strategies is feasible or available to them?
Meghan: So, the first thing I'd emphasize is everyone can benefit from getting educated on the full toolkit that we've discussed today. Second, is not every strategy is gonna be available or appropriate for you. So, for example, to your point, someone who currently works for a company or, or sits on the board, they will have additional rules and restrictions as compared to someone who's just a stock investor. And so, factors like employment status, employee trading policies, eligibility requirements, and the nature of the stock itself can all influence, uh, what is possible. And that's why it's important to work closely with your advisor to understand what's feasible. The good news is we work with everyone, from current employees and execs to investors, retirees, you name it. And so, while the biggest rule of the road is that not every strategy is gonna be available to every investor, the key is understanding early so you can build your game plan around it. And so, that's why we always encourage, in every conversation, it starts with education and planning, because once you understand the rules, it will be a lot easier to curate that toolkit and understand the strategies that fit your particular situation. And oh, by the way, that stock can still be the largest position in your portfolio. It, it just doesn't have to have that outsized voting right on your financial future.
Jamie: So, to wrap things up, having a concentrated stock position has become increasingly common. The risks may often be much larger than people realize, but the menu of strategies alongside the proprietary analytics we have access to and the dedicated specialists on your teams, Meghan and Steve, can really help clients navigate all of those trade-offs and complexity and build a cohesive plan that they can feel really confident about. So, if someone takes just one next step after listening, and I'll ask each of you, what should they do to start a productive conversation about their concentrated stock position? Steve, let's start with you.
Steve: Sure, Jamie. I think investors would be well-served to think about their goals as a starting point for this conversation. To say, "What do I want the next five, ten, fifteen years to look like?" is going to force us to think about goals. And so in, in contextualizing our goals, like do we want to diversify? Do we want to increase our income? Do we want to be more charitable? All of those things would likely spur some action along the HOPES framework if you have a concentrated position. So, that's where I would start. What are your goals for the future?
Jamie: Makes sense. Meghan, what about you?
Meghan: So I would, I would echo Steve's comment that this is not an all or nothing decision, nor is it permanent, and it's not a one-time event. This is a living plan that can evolve as market conditions do. Certainly, your personal life can evolve. Life circumstances change, and so we can tailor what we've discussed today to your pace. And so, you know, at Morgan Stanley, that's why we spend so much time leveraging this framework approach, to help clients and advisors understand the full toolkit that's available, and then determine which solutions may be appropriate based on your individual circumstances. You just need to understand the problem that you're trying to solve, and we can do the rest.
Jamie: Well, Meghan, Steve, thank you very much for taking the time today and walking us through all of this. I think we can all agree this is a very important yet complicated topic for clients to navigate, and it's reassuring to hear the menu of strategies available, the tools and resources that we have at the firm to help clients with this, least of which the expertise from both of you and your teams to help clients navigate this very complex, but potentially very important situation. So, thank you both for your time today.
Meghan: Thanks, Jamie.
Steve: Thank you, Jamie.
Jamie: If you'd like to learn more about managing a concentrated stock position or speak with an advisor who can help you, come see us at morganstanley.com/mymoney. Jamie Roô. Talk to you soon.
Disclaimer: This material has been prepared for general reference and educational purposes only. It does not provide individually tailored investment advice. It has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. Please see our show notes for a full disclaimer on the information provided.
This material has been prepared for informational and educational purposes only. It does not provide individually tailored investment advice and has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. The strategies and products discussed may not be appropriate for all investors.
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HOPES for Concentrated Equity
Morgan Stanley does not provide legal or tax advice. Neither the HOPES Special Report, HOPES Information Request, HOPES for Concentrated Equity Tool nor the HOPES Tool Output Reports (together, “HOPES Materials”) constitute recommendations, investment strategies or advice. Any terms and/or pricing of any products included in the HOPES Materials are indicative, hypothetical and may not be available. Morgan Stanley, including through its Financial Advisors, does not provide recommendations or advice on any prepaid variable forward products discussed in the HOPES Materials. Please note that this is not an all-inclusive list of the features of the products discussed above and not all clients are eligible for these products. To the extent clients are subject to any company trading policies or restrictions that govern their holding of company shares, or the potential sale, hedging or other transactional activity related to such shares, it is the clients’ responsibility to confirm whether the scenarios described in the HOPES Materials are consistent with and permitted by such policies or restrictions, as Morgan Stanley provides no view on whether any such policies or restrictions may limit or prohibit the scenarios described therein.
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