Client Portals

Money is Money, No Matter the Source3 min read

Apr 13, 2011 - John Osbon ( 5 mins to read)

Over your lifetime, you may receive or accumulate securities through gift, inheritance, sale of a business, stock option plans, 401(k) plans, or other sources. How you came into possession of the assets can easily influence investment decisions. For instance, it may seem like treason to sell any of the stock that your father accumulated in his employer’s company before his death. Should emotion play a part in decisions to hold special stocks like this?

The market doesn’t know how you got here

And doesn’t care. Many investors, consciously or not, treat some assets differently because of their source. Partitioning a portfolio this way may result in unintentional but severe overweighting in specific companies, industries or asset classes. Hanging on to Dad’s big block of company stock may honor his memory, but at the potential cost of lower diversification and greater portfolio risk. Any large holdings in individual stocks pose the same kinds of danger.

What is the smell of roasting sacred cow?

Treating any asset as sacred can skew the risk and return characteristics of the entire portfolio. Ultimately the source of assets is irrelevant in wealth planning. Decisions to buy, sell or hold should be driven by long-range financial plans and needs, not by sentimental attachments. There are many ways to honor important people, relationships, or business transactions; hanging onto large stock holdings can be a counterproductive way to do it.

Behavioral finance (BF) studies how investors’ decisions are driven by emotion, perception and other human behaviors. These behaviors are constrained by biases, imperfect information, and tendencies to focus on recent history and data that supports our personal opinions. Holding sacred cows is a great example of BF – making decisions based on emotion, not facts.

How much is too much?

Some suggest limiting company stock to 10% of one’s total portfolio. A case could be made that even that is far too high. Either way, it is important to consider all of one’s holdings in this accounting, including company stock in a 401(k) plan. As many employees take a “set it and forget it” approach to their 401(k) plans, considerable sums of stock can accumulate over time, creating a needlessly risky nest egg.

I have seen portfolios with fabulous gains in single securities, 500%, 1000%, or more.  As wonderful as those gains are, keep the time frame in mind.  For example a stock that has gone up 500% in a generation (25 years) is only compounding at 7 percent, well below the stock market’s long term 9% annual return.  At 9 percent, that stock would have been up 862 percent in 25 years, more than 70 percent more.  And this past performance tells us little about what will happen next.

But what about the capital gains?

Another emotional hurdle that comes into play with large legacy holdings in one or two stocks is the big tax bill upon sale. If shares have been accumulated through stock options at a low cost basis, for instance, the idea of paying fifteen percent on the gain can lead to never selling at all. Unfortunately holding on to the stock may be far riskier than selling and paying some tax.

It is often possible to offset some of these gains to reduce the tax bill. But even if that is not possible, it is important to discuss all available options related to large stock holdings with your wealth manager. No one likes paying taxes at current rates, but it may be worse in the future. Remember that Uncle Sam is always your partner and needs to be paid his share (taxes) eventually. Now may be the best time you will ever have to buy him out.  Important reading for taxpayers: “It’s a Great Time to be Rich” from Bloomberg Businessweek.

With all these factors in play, now’s a great time to consider a difficult question: Are you holding any stocks for the wrong reasons?


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