For those of you who have been lucky enough to hold Apple (NASDAQ:AAPL) stock for the past several years or longer, there's a good chance you've thought about locking in some of the lofty gains at some point during your ownership and diversifying into other investments. This makes sense from a purely statistical standpoint: The fact that AAPL has outperformed the S&P 500 index consistently in the past provides exactly zero indication that it will continue to do so in the future.
But there are important variables to consider when exiting a concentrated stock position -- many of which deal with limiting capital gains tax and controlling risk exposure. Let's take a closer look at what you need to take into account when considering selling a high-growth stock.
Options for managing taxes due
The very substantial gains embedded within a single company holding imply you will have a large tax cost if the position is sold. Typically, this cost assumes the form of long-term capital gains tax, ranging from 0% to 23.8% of realized gains, depending on your tax bracket. If you have a very low-cost basis and don't want to be responsible for a massive tax bill in any one year, you might consider staging the sale of stock over a predetermined period of months or years. This allows you to spread your tax burden out over time and benefit from a diversified portfolio on an incremental basis.
It's important to mention here that long-term capital gains tax will only apply on gains for investments held greater than one year. If you've held Apple (or a similar high-growth tech stock) for less than a year and you decide to sell your stock, you'll have locked-in short-term capital gains that are taxed as ordinary income. In other words, gains on stock held less than a year will be added to your taxable income and receive no preferential tax treatment. The bottom line: be careful to understand that the length of time you've held an investment will impact the amount of tax you ultimately pay.
For example, if in October 2020 you were to sell 20% of your appreciated position so you move closer to an appropriate level of asset allocation, you could sell another 20% in January 2021 to effectively defer a portion of the tax due until 2022. While there is no specific time horizon over which the position must be sold, it's best to balance the need to move into a diversified portfolio with your ability to incur a significant tax payment.
Portfolio risk can affect your sales time frame
If your Apple stock represents all or a significant majority of your total portfolio, the need to begin diversifying is proportionally greater. When you hold single company stock, you're exposed to idiosyncratic risk, also called "company-specific" risk. This refers to the potential for loss associated with Apple's business operations -- and only Apple's. When you hold an assorted portfolio of stocks, index ETFs and/or broad-market mutual funds, you're effectively "diversifying away" company-specific risk and accepting only market risk.
On the other hand, if your Apple position comprises only a small part of your financial capital -- for instance, less than 10% -- you don't necessarily need to be in any hurry to sell. Depending on your other holdings, you may be able to afford the risk associated with holding a single stock position, especially if your goal is to hold for the long term.
Accounting for the holding period
If you're a long-term investor with a relevant time horizon greater than five years, you are likely better off exiting your position for a diversified portfolio sooner rather than later. This has to do with the increased risk associated with holding the common stock of a single company versus holding a globally diversified portfolio. Put another way, a hefty capital gains tax bill resulting from the sale of stock generally turns out to be far less harmful than holding on to a single company (and exposing your money to its unique risks) for long time periods.
The reason to exit a single position sooner is that your risk-reward trade-off is far better when you hold diversified (as opposed to concentrated) investments over long periods of time. On the contrary, if your time horizon for the position is only another one or two years, an argument for holding now with a plan to sell in the future can be made. The logic in this instance is that company-specific risks are less likely to be impactful over shorter time horizons, and it's simply not as urgent to sell immediately. Note that your time horizon is only one factor in the sell/hold decision.
It's more art than science
Managing concentrated positions can be anxiety-inducing, as everyone wants to hold on to their big winners forever and never pay any tax. Unfortunately, tax is one of the necessary byproducts of income generation, and the IRS will happily take a significant bite out of any appreciation you've realized over time.
The important point to remember here is that you'll need to consider all of the relevant variables in your particular set of circumstances. It's entirely possible that the best strategy for you may be to sell everything now. For someone else, it could be to stage a sale over time. For others, holding the stock may be an option. It's generally advisable to take your entire financial picture into account and understand the impact of any sales on your risk profile, tax return, and broader financial plan.