3 Strategies for Highly Appreciated Stocks

June 28, 2024 Hayden Adams
A stock that's experienced substantial growth can be a boon to your portfolio—but also can lead to overconcentration. Here's what to know about managing concentration risk.

When you own a stock that's been soaring, it's natural to want to hang onto it—or buy even more shares to help boost your gains. But at what point does a highly appreciated stock become too much of a good thing?

Generally speaking, when one stock accounts for more than 10% of your investment portfolio, you may encounter concentration risk—the risk that a single asset may have a disproportionate amount of influence over your portfolio's overall performance. If the stock begins to struggle, your portfolio could struggle along with it.

Let's take a closer look at strategies to manage highly appreciated stocks and mitigate concentration risk.

How concentration risk can happen

You may have reasons for retaining a stock even as it takes up a larger position in your portfolio. First, you may not have a choice: If the stock is part of your compensation package, you might be restricted from selling for a period of time. Or maybe you inherited the shares from a loved one and have an emotional attachment that makes it difficult to sell them. Another common situation is to have a single stock appear in many different funds—particularly market capitalization–weighted funds that give a larger allocation to the market's biggest companies—which can lead a person who has invested in funds to inadvertently overinvest in one stock.

Whatever the reason, you should attempt to maintain the value created by your appreciated stock while reducing its influence over your portfolio's performance. Here are three common strategies for mitigating concentration risk.

1. Pare your holdings

Selling some of your shares is one of the simplest ways to reduce your concentration risk. Of course, if you own the stock in a taxable brokerage account, the sale is likely to trigger capital gains taxes, which will vary depending on whether you've held the position for more or less than a year.

Depending on your income level, selling all or a large portion of the shares could push you into a higher tax bracket. To help minimize taking a large tax hit in a single year, it can sometimes make sense to pare down your holdings over a couple of years. Using this strategy, you can target to selling only enough shares to stay within a certain tax bracket. Another option is to pick a tax bill your comfortable paying and selling only enough shares to equal that amount of taxable gain.

Taking an incremental approach may also allow you to capture more gains if the stock keeps appreciating, helping assuage any seller's remorse you might otherwise feel – but it also means your contracted position will take longer to unwind, which could leave you exposed to negative market fluctuations in share price for a longer period.

2. Turn to direct indexing

Direct indexing is an investment solution that allows you to purchase the individual securities that make up an index, rather than buying shares of a traditional index mutual fund or ETF. That way, you can customize the holdings to your individual needs or preferences.

Direct indexing offers two features that can potentially mitigate concentrated positions: 

  • You can "customize" your portfolio excluding stocks that would create more concentration risk.
  • By holding shares of individual companies in an index there's the potential for additional opportunities to recognize capital losses (known as tax-loss harvesting). Those losses can be used to offset any gain realized from selling a concentrated position.

For example, if you already own individual shares of Apple and also want to invest in an S&P 500 fund, you could easily have more than 10% to 20% of your portfolio invested in that company. By opting for direct indexing rather than an individual index fund, you can choose to exclude additional shares of Apple from your holdings and instead swap in a stock that has different risk characteristics or are in a different sector. Then, you could gradually sell down the rest of the concentrated position over several years using a combination of tax loss harvesting and targeting a specific tax bracket. 

3. Give it away

If your wealth management goals include donating to charity or transferring wealth to the next generation, using highly appreciated stock to do so could reduce your concentration risk and offer potential tax advantages.

Donating highly appreciated stock to charity generally makes more sense than selling the position and donating the proceeds, because you can avoid paying capital gains tax and potentially receive a tax deduction equal to the fair market value of the donated shares. You can gift stock directly to a charity or use charitable strategies, such as a donor-advised fund or a charitable remainder trust.

Or you might consider gifting the appreciated stock to a family member—maybe that new graduate—particularly if they are in a lower tax bracket than you. Not only will you avoid capital gains tax, but you could also remove the future potential appreciation from your estate. You can gift up to $18,000 per recipient in 2024 ($36,000 for a married couple) without eating into your lifetime gift and estate tax exemption. Or you could use a portion of your $13.61 million gift and estate tax exemption to pass on the assets tax free.

Just be aware that the lifetime gift and estate tax exemption is set to be reduced by half at the end of 2025, so you may need to act soon.

Talk it out

No matter which strategy you're considering, your Schwab financial or wealth consultant is available to discuss options that make sense for your goals. They can help you think through the various outcomes of holding versus selling your position, as well as the potential tax implications of either approach. 

No matter which strategy you're considering, your Schwab financial or wealth consultant is available to discuss options that make sense for your goals. They can help you think through the various outcomes of holding versus selling your position, as well as the potential tax implications of either approach. 

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Investing involves risk, including loss of principal.

All corporate names and market data shown above are for illustrative purposes only and are not a recommendation, offer to sell, or a solicitation of an offer to buy any security.

The information and content provided herein is general in nature and is for informational purposes only. It is not intended, and should not be construed, as a specific recommendation, individualized tax, legal, or investment advice. Tax laws are subject to change, either prospectively or retroactively. Where specific advice is necessary or appropriate, individuals should contact their own professional tax and investment advisors or other professionals (CPA, Financial Planner, Investment Manager) to help answer questions about specific situations or needs prior to taking any action based upon this information.

Market fluctuations may cause the value of investment fund shares held in a donor-advised account to be worth more or less than the value of the original contribution to the funds.

Strategies that use screening exclude certain investments and therefore may not be able to take advantage of the same opportunities or market trends as strategies that do not use screens. There can be no assurance that the strategies will achieve their desired outcomes. Each investing strategy brings with it its own set of unique risks and benefits.

Neither the tax-loss harvesting strategy, nor any discussion herein, is intended as tax advice and does not represent that any particular tax consequences will be obtained. Tax-loss harvesting involves certain risks including unintended tax implications. Investors should consult with their tax advisors and refer to the Internal Revenue Service (IRS) website at www.irs.gov about the consequences of tax-loss harvesting.
 

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