We have all read the tales of the early employees at Microsoft that held onto their shares for many years, and became multi-millionaires by doing so. Clearly, if these folks had sold off shares over the years in the interest of diversification, they would be far less wealthy today.
But, for every Microsoft story, there are dozens of Enron stories, where thousands of employees lost over a billion dollars in stock value. It has occurred to me on more than one occasion that I would probably have not gotten rich if I had worked at Microsoft in its early days. I am a relentless diversifier, and I would have sold stock on a regular basis.
I know a retired auto executive that owned over $3 million in company stock when he retired. After nearly 40 years with the company, he was quite a believer in the car company’s stock value.
Speaking as his money manager, I implored him to sell large portions of the stock and become more diversified. He did not want to sell a single share, nor did he want to pay any taxes.
Less than two years later, his stock was worth about $800,000, and his long-laid plans for a luxurious retirement were in tatters.
Ownership of concentrated positions is not limited to company employees. I have a family friend that owned a block of stock in a software company. That stake grew to millions of dollars in the late 1990s, yet he continued to keep every share.
Despite repeated friendly admonishments to sell and get diversified, he never sold. His stake has since plummeted back to less than he paid for it.
Mark Twain is reputed to have said, “Put all your eggs in one basket. And then watch that basket.” My friend did exactly that, and he watched as the basket went empty.
Of course, we are all too familiar with the tale of Enron and Worldcom employees who bought company stock.
There are a number of ways to go about reducing large holdings. The simplest is to sell the shares. At the current low capital gains tax rates, 75 percent or more of the sale proceeds are still on hand to buy safer and more diversified holdings.
While nobody likes the idea of writing a big check to the IRS today, the taxes will be due sooner or later anyway. It’s often wiser to pay taxes on profits today and position the portfolio for continued steady and safe growth.
Another option is an exchange fund. An exchange fund is a private investment partnership that consists of a highly diversified portfolio of securities and other assets. The owner of a large block of stock can exchange that stock for shares of the exchange fund. The investor has now achieved diversification, without incurring immediate capital gains taxes.
After a holding period - usually seven years - the investor can obtain a direct distribution of the holdings of the exchange fund, again without incurring immediate taxation.
Exchange funds are limited to the well-heeled, and carry high expenses and fees. They have been the subject of periodic legislative attack that would eliminate their benefits, so investors need to be aware of the risks involved.
Whichever method is chosen, the end goal is to own several baskets with lots of eggs in each one. While a large concentrated stock position has a certain Las Vegas appeal to it, my advice is to cash in your chips and move over to the buffet where there is a lot more to choose from.