With the recent run-up of stock market levels over the past several years, many investors might find one or more of their investment holdings have appreciated considerably in value, now representing a disproportionate percentage of the total portfolio value. Investors must pay attention to these concentrated investment positions. While different measurements can define a concentrated position, it is generally agreed when an investment holding exceeds the market value by 10% of the total portfolio value, it is concentrated.

Managing these concentrated positions can be difficult for investors for various reasons, such as having a very low tax basis. When such positions are owned in taxable accounts, reducing/selling them can result in excessive taxable consequences. Another reason for allowing a position to become excessive can be emotional attachment.

For these reasons, many investors often make poor investment decisions associated with their concentrated holdings. Investors with concentrated positions must adopt a planned process of reducing these position(s), safeguarding their overall portfolio performance. Alternatively, by remaining concentrated in one or more portfolio positions, investors face both market risk and specific risk, where one or more of their concentrated positions decline substantially in market value outside of the investors’ control.

Investors with concentrated positions may like to consider the following questions as to why it is essential to take a hands-on approach to managing concentrated positions:

• Will future capital gain tax rates be favorable when the concentrated position is reduced or sold in its entirety?
• For those investors concerned about tax consequences, how likely is the concentrated position to drop in value more than the tax consequence they are trying to avoid?
• What opportunity cost am I missing out on by leaving the money invested in the concentrated position rather than finding an alternative investment(s) that could perform better?

History has shown that tax laws are flexible, and there is no guarantee that future capital gains tax rates will be favorable. Holding concentrated positions does not avoid paying capital gains taxes; it merely delays the payment unless the goal is never to sell and pass concentrated holdings to heirs or charity. In most cases, concentrated positions need to be sold if the rewards are to be realized. Further, the risk in a stock is more than just the chance of a capital loss; there is also the risk of lost opportunity. Holding a stock that underperforms the market year in and year out can be more damaging than having a stock that falls in value quickly. Concentrated position(s) that are underperforming need to be managed correctly with other holdings while looking for alternatives that can provide outperformance, less specific risk, and better long-term results.

So, what can investors do? Adopt a planned process to reduce concentrated positions! The worst approach for a portfolio with one or more concentrated positions is to do nothing. Investors can either address their position and resolve it through careful planning or let outside forces resolve the issue, resulting in market losses, higher taxes, or a combination of both. Provided here is one approach that investors might find helpful:

• Define your measurement of a concentrated position.
• Organize holdings across all investment accounts to identify any concentrated position(s).
• Develop a plan to gradually reduce these concentrated positions over a set time frame, considering taxable consequences and opportunity costs.
• Find replacement investments that provide more significant upside and long-term performance.

Investors must first define what represents a concentrated position for their investment goals. Is it a benchmark of 10% of total invested assets, or is another measure more appropriate for your risk tolerance and long-term goals? Once determined, investors must organize their holdings across all investment accounts (taxable and nontaxable; spousal, etc.) to identify the concentrated position(s) held in aggregate of all accounts. For those concentrated position(s), investors should adopt a plan to reduce the concentrated position so that it falls back in line with other investments owned. While this rebalancing might be a multi-year process, reducing the holding by a percentage each year until the holding is no longer concentrated is prudent portfolio management. For example, an investor with 20% of his portfolio in a single position could choose to reduce his position size by 6% a year, with 1.5% adjustments made each quarter. This approach allows the investor to use a systematic approach to reduce their concentrated position while gradually building a new position(s). The spreading out of the buying and selling over multiple periods can minimize the timing risk.

In summary, investors must consider the consequences of concentrated positions and have a plan to address these holdings. The first step is always the most difficult, and subsequent adjustments are often easier to implement. The benefits of properly managing these positions outweigh the costs (taxes, opportunity, and emotional) one might incur.

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