Many people who have worked for a company for a long time—including executives—often accrue a concentrated stock holding in one company (usually their employer). This can often pose a problem for the investor in terms of lack of diversification, tax issues and liquidity.

A highly concentrated stock position exposes the investor to significant risk exposure to the fortunes of a single company. In addition, selling the entire position may not be a tax-efficient option if there have been significant 澳洲幸运5开奖号码历史查询:capital gains accrued on the position.

To manage these problems, there are four strategies that can usually be taken to minimize the risk to your 澳洲幸运5开奖号码历史查询:net worth. Not everyone can take advantage of the strategies discussed in this article. Most of the financial instruments described will typically require the investor to be considered an "澳洲幸运5开奖号码历史查询:accredited investor" under 澳洲幸运5开奖号码历史查询:Securities and Exchange Commission (SEC) Reg D. This generally restri𒉰cts tღhe use of these tools to high net worth investors who have a significant non-diversified stock position that they want to hedge.

1. Equity Collars

The first approach is a very common hedging strategy and one that may be familiar to many investors. The equity collar method involves the purchase of a long-dated put option on the concentrated stock holding combined with the sale of a long-dated call option. The collar should leave enough room for potential gains and losses, so it is not construed as a 澳洲幸运5开奖号码历史查询:constructive sale by the Internal Revenue Service (IRS) and subject꧋ to taxes.

In an equity collar, the put option gives the owner the right to sell their non-diversified stock position at a given price in the future, providing them with 澳洲幸运5开奖号码历史查询:downside protection. The sale of the call option provides the investor with 澳洲幸运5开奖号码历史查询:premium income that they can use to pay for the purchase of the put option. Often, many will opt for a "costless" collar, where the premium from the sale is just enough to cover the entire cos⛦t of purchasing the put option, resulting in zero cash outflow required from 💖the investor.

Alternatively, if you want additional income, you also have the choice to sell a call option with a higher premium, which creates a net cash inflow for the investor. However you want to do it, the equity collar will effectively limit the value of the stock position between a lower 🌳and upper limit over the time horizon of the collar.

2. Variable Prepaid Forward

Another popular strategy that can achieve a similar effect as the equity collar is the use of a 澳洲幸运5开奖号码历史查询:variable prepaid forward contract (VPF). In a VPF transaction, the investor with the concentrated s𓆉tock position agrees to sell thei🍨r shares at a future date in exchange for a cash advance at the present date.

Depending on the performance of the stock, in the market, the number of shares sold at the future date would vary in a range. At higher stock prices, fewer shares would need to be sold to satisfy the obligation, and vice versa with lower stock prices. This variability is one reason the use of a VPF is not considered a const♎ruct💮ive sale by the IRS.

The benefit of this approach is the immediate liquidity received from the 澳洲幸运5开奖号码历史查询:cash advance. In addition, the use of the VPF allows for the deferral of capital ꦇgains and flexibility in choosing the future sale date of the stock.

3. Pool Shares Into an Exchange Fund

The first two methods described were hedging strategies using 澳洲幸运5开奖号码历史查询:over-the-counter 澳洲幸运5开奖号码历史查询:derivatives that minimized the downside risk to th🍰e investor. These next methods also attempt to minimize the downside risk, but leave more room to profit on the upside.

The 澳洲幸运5开奖号码历史查询:exchange fund method takes advantage of the fact that there are a number of investors in a similar position with a concentrated stock position who want to diversify. So, in this type of fund several investors pool their shares into a 澳洲幸运5开奖号码历史查询:partnership, and each 🌠investor receives a pro-rata share of the exchange fund. Now the investor owns a share of a fund that contains a portfolio of different stocks—which allows for some diversification.

This approach not only achieves a measure of diversification for the investor, it also allows for the deferral of taxes. However, exchange funds typically have a seven year 澳洲幸运5开奖号码历史查询:lock-up period to satisfy the tax deferral requirements, which could pos🍌e a problem for some investors.

4. Rebalance With a Completion Fund

The last method is a relatively straightforward approach to diversify a concentrated stock position. A completion fund diversifies a single position by selling small 🍬portions of the holding slowly over time, and reinvests the money to purchase a more diversified portfolio. Contrary to the exchange fund, the investor remains in control of the assets, and can complete the desired diversification within a specified time frame.

As an example of the completion fund, suppose you own $5 million worth of ABC Corp. stock, and you want to reduce your exposure to this stock. The stock position has appreciated significantly over time, and you don't want to sell all of the $5 million in one transaction because of the amount of immediate taxes you would have to pay.

Instead, you could choose to sell 15 percent of the position each year, and use the proceeds to diversify into other stocks. So, over time the investor achieves a fully diversified portfolio aligned with their 澳洲幸运5开奖号码历史查询:risk tolerance.

The Bottom Line

In general, most of the strategies described here are best carried out by a professional 澳洲幸运5开奖号码历史查询:financial advisor. However, it is definitely worth knowing your options when it comes to protecting your net worth so you can make a more informed decision when choosing an advisor to execute these strategies.