I recently inherited a considerable amount of a stock I already own. Now the position is close to 35% of my entire portfolio. How do I manage this? Do I sell it all at once or do I hedge with options or covered calls?
We believe no single stock should comprise more than 10% of your portfolio. What you do about a concentrated stock position is often complicated by the tax factor. Since you inherited some of the stock, the cost basis is set as of the date of death from whom you inherited it. If you’ve inherited it recently, you should be able to sell the inherited lot and pay very little in capital gains, depending upon whether the stock has increased in value since you inherited it.
You may need the help of an accountant and financial adviser to help you specify which lots to sell. The lots you previously owned likely have a lower cost basis than what you inherited.
The reason you’re likely worried about holding so much of one position is because it is 35% of your portfolio. If the stock were to fall, you would lose a significant amount of your money. If you are able to sell shares to bring the position below 10% you will reduce that risk.
If you do not want to sell the shares, you can gift shares to your children who may be in a lower tax bracket than you. They will assume your cost basis on the stock, and if they are in a lower tax bracket, they may pay less in capital gains taxes once the shares are sold. You may also choose to donate the highly appreciated stock and avoid the capital gains altogether.
Many people have emotional attachments to their inherited stocks. Others who may find themselves with this problem are those who work for large companies and contribute to a stock purchase plan. When you have a position that comprises a large portion of your portfolio, you need to ask yourself, if you sell and pay the capital gains tax can you retire? Generally, the answer will be yes. Then ask if the stock falls by 50% could you retire? If the answer is no, the decision to sell should be easy.
A covered call is more of an income-producing strategy where if you have a long-term position, you sell a call option to someone who then can exercise the option to buy the stock at a set price when the stock price increases. You receive current income for the option, but lose the upside when the stock increases in price and the option is exercised.
A put is best used to protect you from the downside. For example, if you buy a stock Jan 1st and it increases 180%, if you sell today, you would pay short-term capital gains. You need to hold the stock a year to qualify for long-term capital gains treatment, but you have the risk of the stock falling before then. You could purchase a put that would give you the right to sell the shares prior to Jan 1st at a certain price, eliminating the risk of the loss for the cost of the put. This is a very conservative use of a very speculative strategy.
At Henssler Financial we believe you should Live Ready, and that includes understanding your portfolio management decisions. If you have questions our experts are here to help: