A Practical Guide to Reducing Single-Stock Risk, Managing Taxes, and Building a More Diversified Portfolio
A highly concentrated stock position often represents success. It may come from building a business, working at the right company, or holding a long‑term winner. Over time, however, that success can quietly introduce a new form of risk: having too much of your financial future tied to a single company.
Some investors hesitate to reduce a concentrated position because of capital gains taxes. The tax cost is immediate and visible, while the investment risk feels abstract. But in practice, this trade‑off is often misunderstood.
The key planning question is not whether taxes matter. It’s whether avoiding a known, one‑time tax cost justifies continuing to carry open‑ended, company‑specific risk.
Why Avoiding Taxes Can Increase Risk
Financial Industry Regulatory Authority (FINRA) defines concentration risk as the potential for amplified losses when a large portion of a portfolio is tied to a single investment or issuer. In plain terms, the more financial “eggs” you place in one basket, the more vulnerable your plan becomes to outcomes you cannot control.
This leads to an important, planning‑friendly reframing:
You are not choosing between “paying taxes” and “not paying taxes.” You are choosing between paying a finite, known cost today or continuing to carry concentrated risk with no defined limit while potentially still paying taxes later.
Taxes feel painful because they are visible and immediate. Concentration risk often remains invisible until the wrong year arrives. At that point, someone may choose that diversification is the right strategy, but now the losses have already occurred.
How Severe Single‑Stock Drawdowns Can Be
Broad market indexes can be volatile, but individual stocks face risks the overall market does not. These include regulatory changes, litigation, competitive disruption, management failures, or shifts in technology.
For context, between 1991 and May 2016, the average volatility of returns for the S&P 500 was approximately 15%, while the average volatility of the index’s individual components was 28%. This highlights a critical point: individual stocks are nearly twice as volatile as the broader market*.
FINRA explicitly notes that individual stocks can lose significant value—including their entire value—and that holding all, or most, of your assets in a single stock materially increases risk.
To understand how extreme these outcomes can be, consider long-term research on individual stocks. Research from Hendrik Bessembinder found that only about 4% of stocks account for all net wealth, meaning the vast majority of stocks fail to generate meaningful long-term returns.
Importantly, even within this small group of long-term “winning” stocks, volatility is substantial. Bessembinder’s research shows that these top-performing stocks still experienced large drawdowns along the way—often on the order of 50% or more—before ultimately creating significant wealth over time.
Even the most successful companies in history are not immune to extreme declines. For example, Amazon created approximately $2.1 trillion in lifetime wealth from its IPO in 1997 through year-end 2024. Yet despite this extraordinary long-term success, Amazon’s stock declined 95% from December 1999 to October 2001.
Practical takeaway: When you hold a concentrated position, you are relying on one company to be among the small percentage of long-term winners while accepting the very real possibility of significant losses along the way. In many cases, the potential downside from that concentration risk can far exceed the tax cost you were trying to avoid by not selling.
The “Blank‑Slate” Test: A Clearer Decision Framework
One of the most effective ways to evaluate a concentrated position is to remove taxes from the equation entirely and ask a simple question:
If you had cash today, with no tax consequences, would you invest this much into this one stock?
For some investors, the answer is no. And that answer is important—because it reveals that maintaining the position is not a neutral decision. It is an active choice to remain concentrated, driven largely by a desire to avoid taxes rather than by a thoughtful portfolio strategy.
Managing Taxes When De-Risking a Concentrated Position
Once the decision has been made to reduce a concentrated position, the next step is determining how to do it in the most efficient way possible.
There are generally two paths investors can take:
- Sell and realize gains, while using strategies to help mitigate the tax impact
- Use more specialized structures that may allow for diversification without immediately recognizing taxes
In addition, there are important considerations around timing and income that should be taken into account when gains are realized.
The right approach depends on the investor’s goals, liquidity needs, and overall financial plan—but in all cases, the objective remains the same: Reduce risk first, then manage taxes as efficiently as possible.
Below are several of the more common strategies and considerations we evaluate when helping clients de-risk a concentrated position. This is not an exhaustive list, but it highlights some of the most practical and widely used approaches.
Charitable Gifting of Appreciated Shares
For investors who are already charitably inclined, donating appreciated securities can be an effective strategy.
This approach may:
- Reduce portfolio concentration
- Avoid realizing capital gains on donated shares
- Provide a charitable deduction, subject to IRS limitations
Importantly, this strategy should be driven by philanthropic intent first, with tax benefits as a secondary consideration. When used thoughtfully, donating appreciated shares can also help offset the tax impact of gains realized from shares sold within a brokerage account. For more information, read about Donor Advised Funds.
Tax‑Loss Harvesting
Tax-loss harvesting can be implemented more systematically through Separately Managed Accounts (SMAs) or Unified Managed Accounts (UMAs) that are designed to monitor portfolios on an ongoing basis.
Rather than harvesting losses opportunistically, these strategies often evaluate positions daily, identifying opportunities to realize losses while maintaining overall market exposure through similar (though not substantially identical) investments.
The objective is twofold:
- Generate realized losses that can be used to offset current or future capital gains
- Allow the portfolio to remain fully invested and continue to grow over time
This creates a more dynamic approach to tax management, where losses are intentionally captured during periods of market volatility and can be used to help offset gains from events such as the sale of a concentrated stock position.
Exchange Funds: Deferral With Trade‑Offs
Unlike the strategies discussed above, which typically involve selling shares and managing the resulting tax impact, exchange funds represent a different category of solution. They are designed to help investors reduce concentration without immediately realizing capital gains taxes.
In this structure, investors contribute appreciated stock into a pooled vehicle in exchange for a diversified portfolio, allowing for tax deferral while still addressing single-stock risk.
However, this approach comes with important trade-offs and limitations:
- Multi-year lockups (typically around seven years)
- Eligibility requirements (accredited investor / qualified purchaser)
- Meaningful asset thresholds (often $5 million or more in a single position)
- Limited liquidity during the lockup period
- Fees and structural complexity
- Tax deferral, not elimination
Because of these constraints, exchange funds tend to be more situational and less flexible than other approaches. They can be appropriate in certain cases, but they are not a universal solution and should be evaluated carefully within the context of an investor’s broader financial plan.
Important Considerations When Coordinating Taxes
Beyond specific strategies, timing and coordination play a critical role in overall outcomes.
For higher-income households in particular, realizing capital gains can impact:
- The 3.8% Net Investment Income Tax
- Medicare premium thresholds
- ACA subsidies
- Other income-based phaseouts
Because of this, decisions around when and how to sell should be evaluated within the context of a broader tax picture.
The Planning Perspective
A concentrated stock position is not just an investment issue, it is a risk management and planning decision.
Trying to avoid taxes often leads investors to accept significantly greater risk, even when they would not choose that exposure under normal circumstances.
A more disciplined approach is to:
- Determine the right portfolio allocation going forward
- Accept that taxes are a byproduct of success
- Use available strategies to manage the impact as efficiently as possible
In most cases, the risk of remaining concentrated outweighs the cost of selling.
If you’re holding a concentrated position and wondering how it fits into the rest of your financial picture, a coordinated planning conversation can often bring clarity. We’re always happy to be a resource as you think through the trade‑offs.
FAQ
What is a concentrated stock position?
A concentrated stock position occurs when a large percentage of an investor’s net worth or portfolio is tied to a single company or security.
Is it ever smart to hold a concentrated stock to avoid taxes?
In some cases, but avoiding taxes alone is rarely a sufficient reason. The decision should balance risk, time horizon, and overall financial plan.
What is the blank‑slate test in investing?
It asks whether you would invest the same amount in the same stock today if you were starting from cash with no tax consequences.
Can exchange funds eliminate capital gains tax?
No. They generally defer taxes, not eliminate them, and come with liquidity, fee, and eligibility trade‑offs.
