What Should You Do with Highly Appreciated Stocks?
What should you do with highly appreciated stock? Say you bought Apple or Tesla a couple years ago, and now it is 20% (or more!) of your portfolio. What should you do?
What a nice problem to have! I’ll just say that it is a pretty common problem, as people tend to sell their losers and hold their winners. A lot of people I know have invested in some winner single stocks, and have outsized gains to deal with.
Let’s look at what one might consider when with highly appreciated stocks in their portfolio. And, we will consider how the tides of investing should inform your decision.
It’s a Matter of (Low) Basis
Highly appreciated stock means that it has a low basis. A low basis means it was worth less when you bought it. So, now if you sell it, you will owe long term capital gains on the appreciation between the basis (price you purchased it at) and the current price.
Basis is the purchase price. It may not even be that it was cheap when you bought it, but it just has had explosive growth. I don’t think Apple or Tesla has looked cheap in a long time!
Apple and Tesla are among some obvious current examples. Both have been on a rocket ship to the moon. Maybe they seemed expensive when you bought them a couple of years ago, but now they are worth 10x that or more.
So, a lot of people are asking what to do with their highly appreciated assets. Let’s find out first: do you need to do anything?
What If You Lost It All?
What if your highly appreciated stock went to zero? What if you lost it all?
One saying I like: you get wealthy through concentration and stay wealthy through diversification.
This usually applies to entrepreneurs who start their own business. No, they don’t fund a 401k or have other investments. They put 100% of their time and money into their business endeavor. When it (rarely!) works out, they become wealthy. If they stay concentrated and continue to re-invest just in their business, they either get extraordinarily wealthy or lose it all… and start over again. This is concentration, and it creates wealth.
Many people have concentrated positions in their brokerage account after dabbling in stocks. Again, we tend to sell losers and let our winners ride. Now, they have massive capital gains taxes due if they sell. Remember: gains are just on paper until you sell and lock them in. But, given that only death and taxes are certain, what might be gained by deferring those capital gains? Or…
Consider the flip side: what if you lost everything? The money is not yours until you sell. If you dont sell: how bad could it be?
If the highly appreciated stock is 20% of your net worth, but you have plenty to retire regardless if it goes to zero, then it doesn’t matter what you do. You can ride that winner to the moon. Or crash and burn.
But if you need that money to retire, you must be very careful and… be honest with yourself. You created wealth trough concentration. Now it is time to diversify: take some of the money off the table. Recognize the gains, pay the taxes. Diversify. Move on.
If you can’t afford to lose it all, it is time to diversify.
How might you do that? Next, let’s look at some strategies for diversifying highly appreciated stocks.
Strategies for Diversifying Highly Appreciated Stocks
Here are some strategies to diversify highly appreciated stocks:
- Hold them until you die and get a step up in basis for your heirs
- Donate them to charity or your DAF
- Use a CRUT for current or future income
- Hedge via put options or collaring (will get expensive if everyone is doing it)
- Tax Loss Harvest like crazy (hard to do in an extended up market)
- Bite the bullet and sell some now and the rest later – taxes be damned
- Sell yearly up to the optimal capital gains bracket
- Lose out on Oil and Gas, Opportunity Zones and/or Conservation Easements in order to get a deduction
- Sell on a year you otherwise have a large deduction
Because I’m wonky, I want to dig in on some of the above specific strategies for highly appreciated stocks.
Specific Strategies for Highly Appreciated Stocks
Charitable Bunching and DAFs
Given the high standard deduction, it is best to bunch charity into every other year (or less). Giving away your highly appreciated stock to charity is a great way to re-set the basis. Consider a Donor Advised Fund (DAF). Use the cash you were going to donate to buy stocks at today’s higher basis, and give away the low basis stock that the charity can sell tax free. Win Win. Some call this flushing out gains. I have a blog you might want to check out on optimal giving to charities.
Optimizing Capital Gains Tax Brackets
Remember that capital gains stack upon ordinary income. There is a parallel and some would say evil system of taxation for capital gains. Break points to consider: the top of the 12% ordinary bracket (where you can capital gain harvest and pay no taxes), up to the top of the NIIT surcharge (250k married, 200k single), and up to the top of the 15% (or more accurately when 18.8% becomes 23.8% including NIIT) bracket. This 15% to 20% capital gains transition is pretty near the top ordinary marginal tax bracket (currently 37% but soon 39.6%). See why I called it evil?
The idea here: figure out where your next break point is, then sell enough of the low basis stock to fill up your current capital gains bracket. This could save you 15%, or 3.8%, or 5% on taxes, and is worth looking into every December with your CPA if you have highly appreciated stocks. Evil.
CRUT into DAF
Finally, I really like the idea of taking a ton of highly appreciated stocks and turning them into an income stream. With an irrevocable transfer into a charitable remainder trust, you can then sell the low basis stock and diversify your investments tax free. You get current income (or future income—these can be quite nice given low current interest rates) which is taxed at capital gains rate. You also get a nice tax write off the year of donation, which means jumbo partial Roth Conversions that year. Of course, see your qualified estate attorney for trust and tax advice. Or, if you don’t care what happens to the remainder, see your favorite local charity, university or hospital. They will happily set up a gift annuity for you.
With a CRUT, think about leaving the remainder to your children’s DAF. They can donate the remainder during their lives, which might save them money as they can spend theirs and donate yours. A CRUT into DAF. Brilliant move today for highly appreciated stocks if you want income, a present day write off, and future charitable donations for your children.
The Tides and Highly Appreciated Stock
Finally, let’s get to the tides of investing. For the Ides of March; the tides of a prolonged bull market.
A lot of people have done extremely well with individual stocks as the tide has been rising. It has, in fact, raised all boats. It will not rise forever, and Apple and Tesla will go down in price, eventually.
Do you actually want to hold them until you die and get the step up in basis? What if that was your strategy with GE, Sears, Kodak or Enron, or more than half of the Dow Stocks from just 20-30 years ago? Your children would not be happy with the result.
Holding the S&P 500 or a Total Market Index fund is a much better idea in the long run. If those go to zero, then we have larger problems on our hands than stock prices or sunk boats.
As the tide provide highly appreciated stocks for you, so will the tide take them away. And only when the tide goes out do we see who is swimming naked (not diversified, that is).
Concentration can make you rich, and concentration will take it away too. Recency bias makes you believe you are a good investor, able to pick stocks or even time the market. No, no you can’t. No one can.
If you don’t need the money, then it doesn’t matter what you do. But if you need the money to retire, by the Ides and before the tides, please diversify your highly appreciated stocks.