How to manage large distribution of stock in one company

[Marc1962]

My background info: Couple 47/51, 5 kids, possible ER after windfall

After paying taxes and paying off the mortgage, 56% of our assets will be in the stock of a single company. My basis will be the price at closing (likely 11/30). It's a prodigious dividend payer that has also experienced a large (90%) price increase since the March 2009 trough.

I know it's unwise to have such a large concentration of assets, and I am interested in learning more about strategies for diversifying. I am considering the following:

1. Sell it all upon receipt.
2. Hold it for at least a year to establish long term capital gains tax treatment. Sell a fixed number of shares each month until it's gone.

Are there other options to consider? For option 2, how might I decide what percentage of the original number of shares to sell each month?

 

[LOL!]

I think you need to learn if some kind of option play can protect you while waiting for these shares to go long-term. Is this company's stock highly correlated with a market segment or the stocks of a few other companies? This might lead to other option plays.

I would consult with a specialist in this area and pay them an hourly fee. You can crosscheck their advice if you like and we might learn something at your expense as well. Thanks!

 

[Peter]

If you had the equivalent amount of cash in the bank, would you buy those shares in this company?

Peter

 

[Marc1962]

I think you need to learn if some kind of option play can protect you while waiting for these shares to go long-term. Is this company's stock highly correlated with a market segment or the stocks of a few other companies? This might lead to other option plays.

I would consult with a specialist in this area and pay them an hourly fee. You can crosscheck their advice if you like and we might learn something at your expense as well. Thanks!

Using options as a hedge is an interesting idea. Thank you!

Anyone care to recommend an expert whose time/advice is worth buying?

 

[Marc1962]

If you had the equivalent amount of cash in the bank, would you buy those shares in this company?

Clearly not - it's too risky to invest more than half of our assets in a single company. I guess you're saying that option 1, an immediate sale, is best?

Are there no tactical differences between having cash and considering a purchase versus having stock and considering a sale?

 

[chinaco]

IMO - Diversify as quickly as you can but try to do it tax efficiently.

 

[TooFrugal]

With that kind of money, I would talk to a few specialists - CPAs, tax attorneys, asset protection attorneys, etc. There may be some fancy kinds or trusts, partnerships, income averaging, etc. available to you that would not apply to most people.

I have a pension guy that knows an amazing amount of details regarding pension plans that I never would have though of on my own or even from books because all he does is pensions, day in and day out. So maybe you could find someone similar to help you with your specialized needs, like an expert who helps people with money frmo company buy outs.

 

[DangerMouse]

I think the question you have to ask yourself is how will you feel if the share price of the company in question drops by 50% in the next year if you choose to hold it to minimise tax.

We divest all company RSU and ESPP stock on the day it vests. The way we look at it, there is plenty more where that came from and we like to take our money off the table and put it in the bank.

 

[audreyh1]

We had company stock at 95% of our assets for many years until about 1 year before retiring. That's what let me retire early. I had to let my windfall grow enough to support retirement.

Within 1 year before retiring, I divested enough of the company stock to reasonably fund a minimal retirement portfolio - about 50% of the holdings.

Within 1 year after retiring, I divested more, got down to 33% initial holdings. This gave me a more generous retirement portfolio with room to "breathe".

Over the next 10 years, I divested a little more every year or so as prices warranted. If the stock dropped a lot, I would wait, and when it recovered to near record highs, I would divest a chunk. The cycles were typically 1.5 to 2.5 years. This year I divested a larger chunk because a) I planned to divest most over the prior 10 years and b) anticipation of higher capital gains tax rates.

Obviously I was lucky. The company stock went up and down several times - often by 50% down, and eventual 2x recovery, but I never experienced a sudden permanent drop to a very low price as happened to several companies during the 2000s.

If yours is an established company - particularly with paying a good dividend - and if not exceeding historical high stock prices, I would be more inclined to divest gradually, after taking a large initial chunk.

Audrey

 

[Marc1962]

I think the question you have to ask yourself is how will you feel if the share price of the company in question drops by 50% in the next year if you choose to hold it to minimise tax.

As long as the company continues to support the dividend, I think I'm ok with a 50% drop. The dividend is about 135% of our SWR, so the portfolio can stay healthy as long as the price eventually does fluctuate back up.

We divest all company RSU and ESPP stock on the day it vests. The way we look at it, there is plenty more where that came from and we like to take our money off the table and put it in the bank.

While I'm concerned about the concentration of value in a single company's stock, I also perceive risk in a quick conversion to cash. If I sell it at the first opportunity, I get no dividends, and the money initially is idle. If I reinvest it quickly, I run the risk of buying in at a market top. If I dollar-cost-average into new investments in order to optimize my average purchase price, a large portion of the cash will be idle for some time.

 

[Marc1962]

Thanks for sharing your experience, Audrey. My gut tells me to approach it the way you did, but I'm not yet experienced or knowledgeable enough to trust my instincts. It's good to know that the strategy was successful for you.

 

[Nords]

As long as the company continues to support the dividend, I think I'm ok with a 50% drop.

Read through VaCollector's comments about Bank of America.
http://www.early-retirement.org/forums/f44/bac-wtf-41843.html

 

[audreyh1]

Read through VaCollector's comments about Bank of America.
http://www.early-retirement.org/forums/f44/bac-wtf-41843.html

That's a good caution, but we have just been through a horrible bear market and dividend crippling credit crisis. I would think the risks are much lower now than in 2007.

About stocks being cut in half - it's not so bad if they recover in a year or two. It sounds horrible, but if you have seen your company stock move through several such cycles, it seems normal. Of course, if the stock suddenly takes off well beyond historical levels, like many diid in 1999, you are probably looking at a one time event and might want to be much more aggressive about divesting. Regardless, there is always the single issue risk of a stock to drop significantly and never recover.

Marc, you might really learn from the dividend investors on this forum about how to evaluate the risks to your company dividend. That would really help divestment decisions.

Audrey

 

[audreyh1]

Using options as a hedge is an interesting idea. Thank you!

Anyone care to recommend an expert whose time/advice is worth buying?

An assigned Fidelity "account exec" had mentioned this to me a couple of times. I was never willing to deal with the complexity and always concerned about hidden, unanticipated gotchas. Anyway, your brokerage should have someone who can explain your options. You are probably considered a high net worth customer by whoever is holding your current investments, so they should be happy to provide additional "free" advice. Just take plenty of time to understand their recommendations before making any major moves. And you can always take small steps or try things with small amounts.

It does sound like education is your first priority. I spent a couple of years learning as much as I could about managing my own money before I started any major divestments/investment changes. I got most of my knowledge from reading investment forums and articles on the internet.

Audrey

P.S. And advisors will always suggest an annuity for "guarranteed" predictable income over your lifetime. But the dependable income comes at quite a price.

 

[MichaelB]

As long as the company continues to support the dividend, I think I'm ok with a 50% drop. The dividend is about 135% of our SWR, so the portfolio can stay healthy as long as the price eventually does fluctuate back up.

The issue you have to deal with is not the likelihood of a bad outcome but the consequence if the price falls and does not eventually fluctuate back up.

There are things you can do, however. Even while your dividend income supports you, sell enough stock to fund a reserve covering 2-3 years of expenses. Then hedge part of your portfolio against a major decline by buying put options – portfolio insurance - to protect you until your gains are long term. You can then begin to sell and diversify as discussed above. Having some cash and hedges won’t completely protect you from bad outcomes but they sure do help.

Audrey’s experience seems quite relevant to yours and you would do well to take her advice.

 

[Nords]

That's a good caution, but we have just been through a horrible bear market and dividend crippling credit crisis. I would think the risks are much lower now than in 2007.

We're having the wrong discussion here. I'm not trying to time the market or assess the risks; I'm suggesting that lack of diversification is bad for 99% of the population no matter how high or low the risks may be. I think VaCollector would agree that there was a significant component of investor psychology working against him, too.

If you're someone like Buffett who doesn't mind working 10-hour days on the background reading just to keep up with the business, then a lack of diversification is no problem. If you're not hard-wired to keep up with this stuff then it's tap-dancing in a minefield. It's running across a four-lane highway with a bag over your head. It's blissfully proceeding as if nothing bad is likely to happen-- until it does. Do I have to bring CuteFuzzyBunny back over here to torture some more analogies?

Speaking of Buffett, by early 2008 our ER portfolio was over a third Berkshire and our kid's college fund was over half. We'd been holding the shares for a few years and I was "comfortable" with that AA but I was beginning to wonder when we should rebalance. We sorta had an AA plan but we didn't have a rebalancing clue. Our kid was nearly 16 years old, and we were probably past the limit to holding equities for college tuition.

After some nudging from a few key E-R.org forum members (hint hint) it was with great reluctance (and gargantuan cap gains) that we finally sold at what turned out to be only a few percentage points off Berkshire's all-time high. Along the way we decided to put the college fund in CDs and to come up with a more mechanical rebalancing plan that didn't require so much of our debate and hand-wringing.

By 2009 our tax-swap cap losses had more than wiped out the previous year's cap gains, our portfolio was within its AA parameters, and we have no more debates about when to rebalance. The college fund also had enough for eight semesters at a private school instead of four.

This thread could turn into a debate about the precise degree of risk one is willing to accept. My point is that there's no acceptable degree of risk with this much concentration because the owner of the shares isn't willing to spend the amount of time & effort necessary to handle such a lack of diversification. He also doesn't appear to have an asset-allocation plan nor any mechanism for rebalancing. (But hey, I could be wrong about that.) This is the wrong time to be assessing risks. I don't think I'm wrong about that.

Even worse, if the taxes are based on options exercise and the shares are held for the long-term cap gains, then the risk has gone up by another order of magnitude. Not only could the share prices drop but there'd still be a huge tax bill to pay on the exercise. It's like tap-dancing through a second minefield and an eight-lane highway. Q: How much is "enough"? A: It's all too much.

I'll point out that a lot of people got to ER by exercising their options, selling their shares right away, paying humongous taxes, and not having to worry about "risk". A lot of their co-workers did not, and they're still working. And some of you guys think I was taking risks by volunteering to get shot at for 20 years?!?

After dealing with the basics of AA & rebalancing, I thought that by now this thread would be deep into the intricacies of NUA taxation, along with how much to sell how quickly. None of this "I think I can hold it for another year" stuff.

 

[Animorph]

I had the same problem back in 2001. After thinking about it for about 6 months (and some of that was a lock-up period anyway), I ended up essentially exchanging chunks of my company shares for shares of similar companies (tech) that I though had similar prospects and whose prices relative to my company were hitting new lows. I remained fully invested, just sort of rebalanced and somewhat diversified into roughly 20 different companies.

That worked very well for me. I didn't have to worry about single company volatility, and was over 15% to the better after a year or two over staying put. Eventually I further diversified into a normal asset allocation using funds, though still all stocks. The company never really met expectations and I'm far better off now for having moved out of their stock.

If you like the company and the risks don't look too bad, you may be able to hang on for long-term capital gains, but after that I'd swap out as opportunities present themselves. You may find during that period that you don't like watching the stock price all day and finding your ER date changing by years at a time with those price fluctuations.

 

[jebmke]

I'll point out that a lot of people got to ER by exercising their options, selling their shares right away, paying humongous taxes, and not having to worry about "risk". A lot of their co-workers did not, and they're still working.

This was precisely my situation. I had an option build up from the late 1990s through 2006. I created a program to start exercising options in 2004 and followed it religiously through 2007. ER'd in December 2007 and never looked back. Certainly some of the tranches that I exercised in 2004 and 2005 would have done better if I had held them all to 2007 but I have zero regrets. Many of my peers decided to ride the wave beyond 2007 and are still working today. The stock is still a good stock and many are back in the money but nowhere near the extent that they were in 2006/2007.

Bad things happen to good companies through no fault of their own. It is called non-systematic risk and is what diversification was invented for. Why take the risk of so much concentration?

In addition, I can only guess that the OP is getting hammered on taxes from dividends and this will only get worse next year when dividends are taxed as ordinary income.

 

[audreyh1]

I'll point out that a lot of people got to ER by exercising their options, selling their shares right away, paying humongous taxes, and not having to worry about "risk". A lot of their co-workers did not, and they're still working. And some of you guys think I was taking risks by volunteering to get shot at for 20 years?!?

Well, I got to ER very early by doing the exact opposite - staying concentrated in company stock until it was big enough to diversify, pay my cap gains taxes, and retire.

In my case - the benefit of so much concentration was that it was my best chance to have a stash big enough to retire sooner. When the company went public in 1995 (I had already exercised my options many years earlier when it was private), it still had a pretty low P/E compared to other tech stocks. I knew how solid and conservatively run the company was, and I thought it had a very good chance of doubling or quadrupling over the next 5 years.

1999 was a crazy time with blowouts and then lots of underwater with miserable tax consequences. Fortunately (or unfortunately) for me, my company never did go to excess on the upside, but didn't suffer a miserable downside either.

That I was in my 30s at the time and gainfully employed, with a paid off house, low expenses, and no debt or kids, had a lot do with being able to take this kind of calculated risk. Young enough to recover. And exercising and holding my early option grants had cost relatively little of my savings - so it was mostly gravy.

All financial professionals will tell you to diversify as soon as possible. Personally, I think you should think carefully through how much to do so and how to stage it.

I do think you need to look at steady-eddie dividend-paying established companies a little different than you would start-ups going public and having a huge run. If the prospects are not that different from other similar companies and/or the dividend payout not particularly different, then there probably is no benefit from staying concentrated other than to avoid cap-gains taxes.

Audrey

 

[Marc1962]

Really appreciate all of your ideas and advice - very helpful! I would like to clarify one point - this is not a stock option scenario. I have owned my shares in the acquired company outright for almost four years, and I will be paying long term capital gains in 2010 on both the cash and stock components of the acquiring company's payment for those shares. My basis in the acquiring company's stock will be its price on the closing date (probably 11/30/10), so a quick sale would not result in much of a gain or loss.

Also, I'm not receiving dividends today as I won't take possession of the acquiring company's stock until closing. The first dividend should be granted on 12/27/10.

My biggest concerns with a quick sale are knowing what to buy, making the purchases quickly enough to get the portfolio performing, getting a high price for the sold stock, and paying a low price for the purchased assets. If not for the single stock concentration risk, I would

1. Use some of the cash to build a CD ladder to cover three years of expenses.
2. Allocate more of the cash to a money market account covering two years of expenses.
3. Over the first 12 months, dollar-cost-average the remainder of the cash into longer term investments that improve the overall asset allocation.
4. After 12 months, begin selling the stock in tranches when its price is high in order to fund ongoing dollar-cost-averaging into the desired asset allocation.

I like this idea because it mitigates all of the "sell it all on Day 1" risks and lets me come up to speed more slowly and systematically.

Of course, the risk is real, which is why I'm so interested in all of your thoughts!

 

[ronocnikral]

I appreciate the timing of this thread, as i have been wrestling with selling my more than 600 shares (may not seem like a lot to some of you) of company stock given to me through my 401k match (vested immediately). This chunk of stock makes up almost 1/3 of my total portfolio. it's very difficult when my company's stock has been yielding ~3.9% and i keep fooling myself into thinking i should wait for this ex div date AND a certain price (i also throw in a, "i'm under 30, so it's an acceptable risk"). only to find myself waiting for the next ex div date. of course, as dangermouse says, there will be more stock delved out in my unfortunate subsequent decades of w*rking.

Bad things happen to good companies through no fault of their own. It is called non-systematic risk and is what diversification was invented for. Why take the risk of so much concentration?

as i work for a large "energy" company, I can't help but think, "what if I worked for BP?" (no debate on if BP is a "good company" needed, us peons have very little control or knowledge of what is going on elsewhere).

bottom line: reducing my risk, putting money else where in my 401k this week. all thanks to this thread.

 

[Bestwifeever]

Wasn't there an energy company called Enron....

 

[ronocnikral]

touche. i work for an E&P company, so i tend to not to relate the two. but...point well taken.

 

[kcowan]

Bill Gates, Warren Buffet and Carlos Slim all made their money by holding a limited varitety of stock. But then they can afford a meltdown now.

My FIL held his company stock (his only holding) until it was worthless.

Because you have no special tax liability, I think you can afford to begin a program of diversification immediately (Jan. 1). Select high quality individual stocks (or ETFs if you can't get comfortable with all the individual decisions).

PS: DW and I still hold $150K in our company stock (for old times sake). But it has been a consistent dividend payer. And it is currently trading within 8% of its all-time high.

 

[DangerMouse]

I don't think if you divest yourself of your stock there is any pressure to do anything with the money. Stick it in the bank for a while until you work it out. I would rather have cash in the bank earning 1% than keeping money in shares that might be losing 10%. I really think you need to diversify unless you are more than happy to keep working forever if the market goes south.

Audrey's situation is not unique, I know other people who benefited as she did. However, this was thru the end of the 90s, don't hear of anyone getting rich and becoming millionaires thru options very much these days. We know people who purchased their options so as to minimise their tax burden, within the year the share price had halved. One person we know admits he has losses in the region of $250k which he is able to deduct $3k at a time. 10 years later the company involved, their price has not yet recovered.

I think you have to decided where you sit on the comfort scale. Do you want this to be your ticket out of work, are you happy if it just enhances what you already have or are you prepared to ride the rollercoaster?