How To Diversify One Stock With Massive Gains (Tax Tip)

They have a massive stock gain and they said Ari , how do I think through making sure I don't pay any more in taxes than I need to ? I said , great , this is an awesome podcast topic . So I'm going to go through my example today on this . A lot of you are going Ari , I don't have a massive stock gain in one position , I have it in multiple positions .

How do I think through that ? What do I think through tax wise ? A lot of people that want to retire early . They don't just have a Roth IRA , they don't just have an IRA , they don't just have a 401K .

They have brokerage accounts , taxable accounts , joint accounts , which , of course , all mean the same thing , and these are amazing accounts that you can use to tap into to keep your income low for tax purposes and you're able to invest as much as you'd like and for an early retirement . It is a very powerful account .

So I'm going to connect all the dots for everything I just went over in just a moment . Today , it wouldn't be the early retirement show without going through the review of the week . And this comes through . Henry , who says Ari was skeptical initially , tuning into your content . You seem young , but you also seem like you like this stuff .

Been watching you for a few months now and impressed and look forward to Mondays .

Awesome , henry , glad that it has been helpful , want to keep making this content , and I am young , and for a lot of you , you already know that , and I view that as a gain , and the reason for that is I'm obsessed with this stuff and I want to be with my clients for the next 30 , 40 plus years .

Now , I'm not obsessed with numbers because of numbers sake . I'm obsessed with helping you get the most out of what you've worked so hard for , if we can use numbers to do that . That's why all this planning stuff is pretty cool to me .

I promise not a total nerd in the sense of I just go out , look at numbers all the time , but I do like looking at them , because they can really make you live a successful life .

The goal here is , though how do we connect the dots , and so , whether it's talked about what we're going to go through today , if you have a massive stock gain awesome how do we pay the least amount in taxes possible , but also understand what does that mean for our life goals ? Can we spend a little bit more because of that awesome stock gain ?

Or do you really not give yourself permission to do so because you're like , oh my gosh , I'm going to have to pay all these taxes on it ? There's all these different mental shifts that I find fascinating , and the last thing I want is for you to living with guilt of any kind because financially , you just don't have confidence around your money .

So I'm going to go through this today just to dial it in for you . Hopefully it's very helpful , and if it is , of course , please do leave a review on the podcast . It's how more people find the show over 200,000 downloads and my goal is to help a million plus people retire early . So thank you for your help in helping me do just that .

So let's hop right in , and this comes from a current client . Like I said before , they have a very healthy position and they have non-company stock , meaning they just chose it on their own , despite working for a current company and the value is around $800,000 .

And so they said in a meeting with me , they said , ari , I know I should diversify , but I feel like I'm kind of in the camp of I know enough to be dangerous . I know there's going to be tax implications . What am I missing ? What do I need to think through ? And here's the reality .

The reality is and a lot of you are going to go yep , ari , I know this , but you're not going to think about it in the way I'm about to say it which is , a downturn in a single stock is and could be so much more damaging than your tax bill . It's natural we think about the tax bill .

It's not natural for you to think about the reality which , if that position that has a massive gain goes down in value , that's way more damaging than paying taxes . And here's why your tax bill is limited to 23.8% of your gain at the federal level . No tax on principle , just on the gains . 23.8% , excluding state taxes . That is the limit .

Now , of course , every single state is different , but that's what we need to think about , at least federally . That's the most you could pay . What's your downturn risk ? So now we know our tax risk .

Our tax risk is if we sell today , there's a 23.8% gain , that's net investment income tax plus based off of income levels unrealistic , you would pay that amount , but that is the highest . Now the real risk is it goes to zero . It can take out your whole position If that goes down , and it's extremely unlikely .

But think about GoPro or Blockbuster , and then what I would argue to think about a step further and this is really the emotional side of things what about the sleep you may lose from thinking about if this could happen to you ? That's an additional risk that's not so quantifiable . So the first thing to do is understand the real risk . Got it ?

There's that tax risk . Okay , real , not fun , but understood . There's that . What if it goes to zero ? And then there's the how am I sleeping throughout this whole process , knowing if it does go to zero ? Oh my gosh , what does it mean for my retirement ? So , yes , an individual stock position certainly has the potential to outperform the market as a whole .

Let's just clear that out , out right away , because a lot of people will go all right , I'm just gonna diversify . It's simple , it's easy , I go . Good , I understand it , I implement that . It makes sense to me , but too many advisors , in my opinion , go never buy individual stock positions . Now , what's the goal ?

If the goal is you work for a company and you feel really strongly in terms of where you think it's growing , or even if you don't work for the company and you just believe that's one company that's gonna do tremendous things , you don't just have to diversify . You're allowed to own that position outright .

You can own it in an ETF , but in this example , you just own it outright because you believe in the company . Wonderful , I actually promote that . I want you to think through this . I just don't want you to put everything in one basket and if it doesn't perform well , it's oh God . Now what do I do ?

It can also , of course , underperform , so I'm gonna hit you with some data now . I think you're gonna find interesting . So the first question that this client asked me and I'm not laughing I know a lot of my clients .

One , they listen to the podcast and they become a client , and then a lot of current clients still listen because they just like tuning into the show , and so if you're listening right now , you know who you are , that these are . I know you gave permission .

I just want you to feel ultra familiar and comfort that when I am laughing or making any of my bad jokes as I'm going through this , this that you're telling me I have permission to talk to the whole world about it is helping tremendously . So please don't take my tone in any derogatory or misleading way . So I'm laughing here .

He said should you sell stock in all cases ? No , not in all cases . And then he said when shouldn't you be concerned about it ? When should I not worry about this ? Well , if you can survive the worst case scenario and still be okay , both financially and emotionally let's clear that also Well , then it's okay . And here's an example Two people want to retire .

They determined both of these people , they want to spend the same amount . They need $80,000 a year from their portfolio to supplement their lifestyle . Now , all two million in this example is in a brokerage account . The first person has 1.6 million in a diversified portfolio and $400,000 in Amazon stock .

Okay , so person number one , they've got two million bucks , 1.6 , diverse , 400,000 just Amazon stock . Now let's pretend market is just horrible . Cuts the market value of Amazon by 70% . Is that likely ? No , but let's just take an example . Have we seen crazier ? We have . So what does this do to this portfolio ? The 1.6 million that stays , okay .

It's diversified . Maybe there's a little bit of Amazon in it already , just through ETFs or other things , but let's just keep it simple . The 1.6 million stays . The $400,000 of Amazon that turns to 120,000 now of Amazon . It's lost a lot of value . So now your two million isn't two million , it's 1.72 million .

That 1.72 million that can still generate $86,000 a year using a 5% withdrawal rate . Okay , the reality is , could you pull more ? Yes , but we'll talk about that and I have talked about it in different episodes , talking about the guardrails approach . So you can still generate $86,000 a year . And remember , at the beginning you needed $80,000 a year .

So was it fun no , was it emotionally difficult ? You bet it was To see 400,000 go to 120,000 . Are you okay ? Yes , you are okay . So it doesn't mean you need to sell . Okay , what about this other investor ? Let's assume this other investor . They have the entirety of their portfolio , all two million Amazon stock . Now , what would that go down to ?

Well , now , let's say that goes down to , let's just say , 600,000, . Okay , that two million goes down to 600,000 . Now , what is a 5% withdrawal rate on that ? Well , that's about $30,000 a year . That's $50,000 short of the 80,000 we need .

So I look at this and the first thing I would do is I'd go these withdrawal rate rules that I talk about , you know , 5% , 5.5% . That applies to a diversified portfolio , not to a single stock .

So if now you have 600,000 Amazon stock , I really wouldn't feel comfortable putting a 4% or 5% or even 3% withdrawal rate on that , because that historical performance of these withdrawal rates is based on a diverse portfolio . But let's ignore that for a minute . Let's just solely look at this example . Now .

You can imagine it's gonna be really tough to go to meet your early retirement goals because you have everything in one position . Now a lot of you are listening to this and you're going already . Yep , this is resonating . So far , you know , hopefully , of course . But when are you gonna start talking about the taxes ? Like , that's what I'm waiting for .

I promise I'm getting there . So , first thing , does it come down to a rule of thumb , meaning , should I own 10% , like , is that the most in one stock , or 5% ? And some people say that . Some people do say it's 5% or 10% . Here's the better approach . It's not a certain number . I'm anti-cookie cutter . You know that by now .

Probably the better approach is how much could you afford to lose ? Let's use a crazy example . You just inherited $100 million . You only need $50,000 a year to live on . You don't want to spend more than that . Even if you tried , you couldn't do it . You don't have it in you . You determine $1 million can fully support that forever .

So you just , once again , you inherited $100 million . You determine $1 million is plenty . You could theoretically invest 99% of that $100 million in a single stock , as long as that 1% or $1 million was properly invested . Is it smart ? No , it's not smart . But the point of this example is could you afford it financially ?

Yes , if you could afford it financially , emotionally you'd probably need a ton of therapy , but the reality is that when you're looking at this , trying to think about what the pain would feel like versus actually feeling that pain when it's gone , those are two very different things . Okay , now that's just one side of the story .

In this example , once again , this person only wants $50,000 a year . I'm jumping around a little bit , but this is the person who just inherited $100 million . You only need $50,000 a year . So if you have a million bucks and that can support you forever . You can lose the other 99% . Who cares ?

Well , you're going to care if you don't want to spend $50,000 a year , but you want to spend $200,000 or $300,000 or $500,000 a year and it's , how do I invest really well with that ? Now we're going to get to the other considerations in a moment here , but here's what you have to ask yourself .

Number one well , I kind of said number one before Number two should I say could you live with the potential downside ? I've got my little outline here but I like to kind of jump around where I think it resonates . So you have to ask yourself could you live with the potential downside ?

The probable downside if you look at individual stocks , is that you will underperform the market . There was a study done by JP Morgan it was called the Agony in the Ecstasy and it showed that if you went all the way back to 1980 , two out of three stocks in the Wilshire 3000 index , which is a bunch of different positions , underperform the Wilshire 3000 .

The best performers . So that kind of the top 10 , top 20 , top 30 , those really drive the performance as a whole . So you look at your return , you look at your statement , you go hey , I got 10% , that's pretty good . Well , in large part it was due to a few really big performers .

Then , of course , is the devastating downside , and there was a JP Morgan study and they called this the catastrophic losses . That's where you can think about of recent times . Silicon Valley , bank or Enron or any of these things happen that aren't that common but very real , and it can be a big tech downturn or all of these different things .

So , thinking about the tax liability for a moment , you've got this big position and you're going . All right , I don't wanna pay a ton in taxes on it . I get that , but oftentimes paying potentially 23.8% could be a whole lot better than losing 50 or 60 or 70% in value .

And so , as you can imagine , a lot of this comes down to how much do you wanna spend , how long do you need this income to last , and emotionally , how would you feel if that stock went down 50 , 60% , you didn't sell , and how would you feel if it went up 50% and you missed out on that upside ?

Some people just cannot sleep at night knowing it would have gone up 50% or 60% and they were not part of that wave . And for those people , I have to show them that when it comes to financial planning , that is a real aspect , that is an emotional , true feeling they have .

But if they don't make any changes , they're not gonna be able to reach their other goals and their other goals aren't . I promise you just to be able to see a 50% increase . It's to work two years less or to send kid to a different college or to do something real as opposed to just looking at returns . So that's kind of the summary so far .

Hopefully that's been helpful . A few other considerations . If you're still participating meaning you're still adding new dollars that can be a really healthy way of staying invested in that position . If you're still working , you don't have to put a ton to it , but you can go .

Yeah , I'm still adding more dollars to this company and I get to participate in the growth of that . That I really like thinking through . The other thing is are you automatically happier with all your money in one stock ? My parents , just so you know they hear me talk about diversification all the time .

I've got friends they hear me talk about it all the time and a lot of them have a lot in one single position and you can tell because I've been an advisor for a little bit . Now that they go sorry , I'm kind of hesitant to tell you this that I have this amount Because they think I'm gonna cringe and go oh my gosh , what are you doing ?

That's not my feedback Now . Sometimes they go wow , that's a lot in a single position . But if I know they're gonna be okay , because they only wanna spend 50,000 a year for the next 40 plus years or they only wanna spend X , y , z and they've got 5 million diversified elsewhere , I'm going good for you . I recommend doing that .

They're like what on earth are you saying ? Shouldn't I just diversify ? I go , not all the time . It doesn't always make sense to do so just because that's kind of what articles online often say . I've worked with clients that have worked at companies who stocks did insanely well , but it was never a smooth ride . That ecstasy and agony , that was very real .

And the worst part of all of this is oftentimes people become obsessed . They become obsessed . They check the value of that stock in the morning , at night and seeing the net worth change . Those six figures it's not seven figures , it's almost at eight figures why am I back down to six figures ?

That can occupy a ton of energy and attention , and do you really want that ? That's the question . Most people don't , so I hope that this is helpful . Now an overall kind of summary , quick on tax wise . If you're gonna sell , ideally you don't have to do it all at once . You can space that over time . Can you sell the long-term gains first ?

Are there other losses in your portfolio you can use to offset that ? Understand the tax liability of selling versus the risk of holding . Once again , tax liability of selling versus risk of holding . There's so much more I could go into on this and I want to , but I also know it's I don't want to overwhelm and I want to make sure that you walk away going .

Yep , I've got a clear sense , if I have a very heavy portfolio position , that I can think through this and I have some clarity there . If you're wondering on how to actually go through this in full depth in relation to your whole plan , it's that anti-vacuum planning concept I talk about , where it could be an amazing investment .

You might have Amazon stock and it's incredible . You might have Apple and it's done incredible for you . But now how do you make those actually work for you ? Well , I'm gonna imagine you want to create income in early retirement and you want to do so as effectively as possible .

That's where we start to use these things and if you're working with an advisor right now , ask themselves what is the tax game plan with my individual position ? So often it's hey , it's a good position , it's doing well . Fundamentals look good . It's rare that it's okay . Should I sell a little bit over time ?

Still stay invested , but understanding that I have enough that if it did go down I would be okay . Oftentimes I see 20 , 30 , 40% in a single position and if it did go down significantly they would not be in a position to retire and you don't want to have all your eggs in that one basket . So hope this episode was helpful .

If it was , please do let me know . Of course , leave a review . I tell more people find the show . I love getting to do what I get to do . So thanks to all for listening to this episode . Love you guys . Thank you for listening to another episode of the Early Retirement Show .

If you have a question that you want answered in a future episode , you can always go to my website , earlyretirementpodcastcom . That's earlyretirementpodcastcom , and you can go ahead and submit a question that I'll look to answer in a future episode . Thank you all for listening .

Please do rate it , review it and share it with someone who you think would benefit from this information . If there's anyone out there that you know , I certainly appreciate it and I will see you all each week . Hey guys , it's me again . Please be smart about this . Nothing in this podcast should be construed as financial , tax or legal advice .

Consult with your tax preparer or financial advisor before taking any action . This podcast is for informational purposes only .