2020 was a year to remember if you held shares of stocks like Zoom Video Communications (ZM) +350%, Tesla (TSLA) +600%, and Moderna Inc. (MRNA) +500%. Returns like these are reminiscent of the dog that always chases cars. You wonder what the dog would do if he ever caught one!
It’s the same thing with these high flying stocks. What do you do when you’ve hit an unmitigated home run? Sit on your hands and hope that history repeats? Now that you’ve got something to protect, you are likely to feel risk much more acutely.
For example, without rebalancing, having a high flyer in your portfolio may expose you to a much higher stock allocation than you otherwise would be comfortable with during a bear market. Further, having a concentrated stock position may expose you to undue company risk.
Let’s say you realize it makes sense to reevaluate your portfolio in light of your good fortune in 2020. The first thing you have to consider is the tax consequences of any sales. If you have held some of these highly appreciated positions for less than a year, you will have to pay ordinary income tax rates on your gains. At worst that would be a 45% federal and state haircut on those gains. Not interested in losing nearly half your gains to income taxes? You need a plan to minimize your tax exposure.
After developing a plan to minimize the potential tax hit to your gains, you now need to determine what percentage of those big winners you will retain in your portfolio. In our experience, clients with highly appreciated stock positions rarely exit those positions entirely. A scenario analysis with various downside projections can help you to arrive at a more prudent allocation for your big winners.
If you have both pre-tax and after-tax accounts, there are strategies that can help you to maintain reasonable exposure to your favorite stocks, without suffering immediate tax hits. If you expect to earn short-term gains, they are best realized in a retirement account.
Humphrey Neill, founder of Contrary Opinion Forum, offers this timeless advice to investors: “Don’t confuse brains with a bull market.” If you’ve been fortunate enough to realize some outsize winners in 2020, congratulations; but don’t assume your good fortune will be rewarded in the future. Nothing lasts forever – especially in the financial markets. Now is the time to develop a strategy for preserving those gains.