Most financial advisors are occasionally faced with clients whose portfolios are weighted too heavily by the stock of a single company. Often, these individuals are approaching retirement, having bought or received a particular employer's stock over many years, or they have inherited the stock upon a relative's death. But whatever the reason, it can be tough to convince them of the need to diversify. Advisors suggest various approachesthough they acknowledge their clients' concerns.
It's not an easy situation, according to Judith McGee, chairwoman and CEO of McGee Wealth Management, in Portland, Ore., who says she can relate. McGee's firm, which manages $406 million in assets, has been affiliated with Raymond James Financial Services since 1989. Along the way, she has amassed a large quantity of Raymond James stock in bonus compensation, which now accounts for a significant percentage of her own portfolio. She knows based on her professional experience that she needs to diversify, but if she sells the shares, she could be forced to pay taxes on the capital gains.
What does McGee tell clients in similar situations, whose portfolios are overweighted by shares of one or just a few stocks? She advises them to sell those shares, or at least to invest in hedges against downward movement of the stock.
Alternatively, if she feels the client can afford it, she proposes gifting the stock to heirs or to charities. McGee also sometimes advises clients to put the stock in a charitable remainder trust so they can continue to receive dividends, retaining some of the stock benefits without facing the potentially heavy tax burden associated with selling.
Often, people in such situations must disconnect emotionally from a treasured stock before they can sell it. "We always ask clients if they have a sentimental attachment to anything," says Peg Eddy, a founder of San Diego-based Creative Capital Management, which manages $258 million in assets.
Sometimes, the answer is yes. The holdings might be shares of a company for which the client, a spouse or parent worked. One of Eddy's clients held about 70% of her assets in shares of an oil and gas company passed down from her grandfather to her father to her. The good news: With each inheritance, the tax basis of the shares resets, so when she sold the stock, the client had fewer capital gains than her grandfather would have had if he'd lived to sell it.
What's more, the client had recently sold her own business for cash, so she had money to buy new assets for her portfolio and "flood it," reducing the inherited shares' proportional dominance.
Then there was the client whose grandmother had passed down shares of Procter & Gamble, accounting for about 60% of the client's assets. "There's only so much Crest and Charmin we can leave in a portfolio," Eddy says.
But in this instance the client refused to follow Eddy's advice to sell. So Eddy helped the shareholder open an account at a discount brokerage and move the shares there. But she also had the client sign a letter acknowledging that Eddy bore no responsibility for those shares. "I'm not going to keep trying to push a rock up a hill," Eddy says.
Another of Eddy's clients held 25% of his investable assets in a company he had helped start, but no longer worked at. "He didn't have his ear to the ground," Eddy says. The company had been churning rapidly through chief executives, but the client was extremely reluctant to sell. Eddy proposed putting the shares in an irrevocable charitable remainder trust that the client and his wife had already established.
The trust distributes a fixed percentage of its assets to the couple, but upon their deaths the balance will go to a charity. The trust could also sell shares, without any capital gains tax consequences for the couple. "It was an ideal solution because it solved emotional, financial and tax needs," Eddy says.
Roger Kruse, who owns FFP Wealth Management, a Minneapolis-based firm with $85 million in assets under management, drills down into the tax consequences for clients whose portfolios are heavy with equity from their employers. In many cases, these are large local corporations such as 3M and Boston Scientific, and the client places less sentimental value on the shares. "The majority of these clients are not as emotionally attached to the stock as they are worried about the tax consequences," Kruse says.
DISLODGE THE LOVE
For those who do cling to stock holdings for sentimental reasons, Kruse says, "I do work to dislodge their love of the stock."
If that fails, he evaluates the portfolio excluding those shares. If the client could afford to have the stock lose 100% of its value, Kruse says, he stops pushing the client to let the stock go.
GIVE AWAY... OR CHIP AWAY
To prod her clients to consider charitable giving of stocks clogging their portfolios, Alexandra Armstrong, chairwoman of Armstrong, Fleming & Moore, an RIA in Washington, D.C., with $650 million in assets under management, cites Facebook founder Mark Zuckerberg, who recently donated 18 million shares of his company, worth $990 million. She stresses that it's better to give away appreciated securities than cash.
Some of her clients have chosen the charitable remainder trust route. For those who resist, Armstrong attempts to "chip away" at the holdings, by convincing the client to sell off some of the stock each year.
HEDGING IS CRITICAL
Hedging is another possibility. Tim Painter, president of Lindus Advisors, which was formed to manage the affairs of a small group of wealthy families, likens hedging to nutrition: We all need it, he says.
Painter, whose Dallas-based firm has $25 million in assets under management with 30 households as clients, says he develops low-cost investment alternatives as hedges for clients who hold a large percentage of their assets in a family company's stock. Those clients typically have no intention of selling that stock, for legacy reasons, but they want some kind of hedge against a downturn in the company or industry.
Painter describes his hedging tactics as "financially engineering a lower-risk profile than if the investor had relied upon traditional asset allocation and diversification." And he adds, "It allows us to be in the market without being at the mercy of the market."
Painter believes his firm has devised cost-effective, sophisticated ways to apply hedging techniques that were limited previously to the purview of large institutional investors because of the high costs of implementing and sustaining them. The trick to keeping the costs low, he says, is constant vigilance and ingenuity for each client's portfolio.
"This is not as easy as allocating to a mutual fund model," Painter says. "You cannot with the press of a button rebalance 1,000 clients' portfolios in 10 minutes."
FOLLOW YOUR OWN ADVICE
As for McGee, whose Raymond James holdings occupy more than their fair share of space in her portfolio, she is slowly but steadily working to follow her own advice and correct the imbalance. The advisor is gifting shares to her grandchildren, nephews, nieces and to universities.
This way, she says, many people will get a little of what she, at this life stage, has too much.