Addressing Concentrated Stock Positions in Client Portfolios
A concentrated position in a portfolio is often an outcome of success. Investors might have gotten equity grants from their employers. Their business or investment might have had a successful initial public offering (IPO). Or perhaps they bought a stock that subsequently had strong performance. Now the question is, how do they preserve and grow their wealth over time? Keeping the concentrated position could expose their wealth to significant stock-specific risk. However, if they have a low cost basis for the stock, diversifying could come with a large tax bill.
One solution to this problem is to use an exchange fund—an investment vehicle that allows investors to exchange their concentrated stock positions for shares of a diversified portfolio without realizing capital gains taxes. The diversified portfolio includes stocks contributed by all investors to the fund.
In this article, we first discuss how an exchange fund works and then compare it with two alternative approaches: (1) keeping the concentrated position and (2) selling the concentrated position and buying a broad market exchange-traded fund (ETF).
Disclosures
This webpage (the “Webpage”) relating to exchange funds is provided by Dimensional Fund Advisors LP and its affiliates (collectively, “Dimensional”) solely to the recipient (the “Recipient”). The Webpage is considered to be confidential and/or proprietary by Dimensional, should be treated in a confidential manner, and may not be transmitted, reproduced or used in whole or in part for any other purpose, nor may it be disclosed without the prior written consent of Dimensional.
The Webpage is not intended by Dimensional as an offer to sell, or the solicitation of an offer to purchase, an interest in any security. The information set forth in the Webpage is provided for informational and discussion purposes only. It is not intended to be, and shall not be regarded or construed as, a recommendation for a transaction or investment, financial advice, or other advice of any kind. Any offering will be made only by means of a confidential private placement memorandum or other appropriate offering materials (the “Offering Documents”) that will contain detailed information about an exchange fund and the execution of a subscription agreement for such fund. Any investment decisions should be based solely on the information in the Offering Documents and after consultation with an investor's independent advisors.
Neither Dimensional nor any of its owners makes any representation or warranty, express or implied, as to the accuracy or completeness of the information contained in the Webpage.
An investment in an exchange fund would not be appropriate for all investors and involves important legal, operational, and tax consequences and investment risks, each of which should be independently assessed by investors with their professional advisors before investing. The Webpage does not purport to be all-inclusive or to contain all of the information that the Recipient may require to invest in an exchange fund. The Webpage does not take into account individual investor circumstances, objectives, or needs. No determination has been made regarding the suitability of an investment in any fund for particular investors.
Nothing contained herein is, or shall be relied upon as, a promise or representation as to the past or future. Dimensional, its directors, employees, and/or agents expressly disclaim any and all liability relating or resulting from the use of all or any part of the information in the Webpage or any of the information contained therein.
THIS WEBPAGE DOES NOT DISCLOSE ALL THE RISKS AND OTHER SIGNIFICANT ISSUES RELATED TO AN INVESTMENT IN EXCHANGE FUNDS. BEFORE INVESTING IN A FUND, PROSPECTIVE INVESTORS SHOULD UNDERSTAND THE FUND'S TERMS AND ANY APPLICABLE RISKS, SOME, BUT NOT ALL, OF WHICH WILL BE DESCRIBED IN MORE DETAIL IN THE OFFERING DOCUMENTS.
The Dimensional US Equity Exchange Fund I LP is distributed by DFA Securities LLC, a broker-dealer registered with the US Securities and Exchange Commission and a member of FINRA. DFA Securities LLC is an affiliate of Dimensional.