The Enviable Dilemma

Abstract

It's not unusual for investors, fiduciaries, and trustees to find themselves with too much of a good thing: owning or overseeing a large quantity of a highly appreciated low-basis stock. In this emotional issue, investors are typically torn: hold the stock that's made them rich and avoid the large tax bill, begin to diversify, or hedge? On average, investors haven't gotten paid to take on the incremental risk of single stocks. But that fact alone isn't enough to act upon? and indeed there are no singular answers. In this study the authors present an analytical framework that highlights the critical trade-offs underlying any single-stock decision, which has to factor in the investor's unique circumstances. These include his long-term goals, risk tolerance, and total portfolio, as well as the volatility of his single stock. We use all of this information to identify courses of action to consider. This analysis can be applied to other risk-management diversification strategies, such as liquidating over time and hedging with derivatives.