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Consider a person with the following financial situation:

  • An annual income in the 150-250 thousand $/year range
  • Savings in the 250-750 thousand $ range (invested in Vanguard ETFs, for example)
  • A windfall of 2 million $ worth of shares from a former employer going public. The person used to work for company XYZ, received stock options as part of their compensation, and that company has now gone public. The person has owned the shares for long enough that they would be taxed as long-term capital gains if sold, and the person is not constrained by a lockout period -- they could sell all of the company XYZ shares today if they wanted to.
  • The person does not have any debt. They currently rent their apartment. However, they are considering purchasing a home in the next 1-2 years.

Should they person sell all of their company XYZ shares and buy ETFs? Should they sell some of the shares? Or should they sell none of them? What are the major tradeoffs worth considering?

From a diversification perspective, a very large fraction of this person's wealth is now concentrated in company XYZ. That's very risky! However, if they sell, they'd have to pay state plus federal long-term capital gains tax. Is there a generally accepted optimal thing to do in this situation? The advice the person has received from friends and family is "keep all your XYZ shares if you believe in the company; otherwise, sell all of them immediatley." In what situations would it be preferable to instead sell a fraction of the XYZ shares, and keep some of them?

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  • "they are considering purchasing a home in the next 1-2 years." I'd strongly consider selling enough to cover the house (plus LT CG tax).
    – RonJohn
    Jun 11 '21 at 2:51
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Long-term capital gains taxes are fairly low, and moreover there's a good chance that such taxes will have to be paid at some point anyway (you'll sell later if not now). The advantage of diversifying away from a single stock (that dominates your net worth) is considerable. You wouldn't want to retire early and/or get used to feeling rich, only to have XYZ go bankrupt, which could well happen.

The classic question is, if you didn't own XYZ, would you buy it (and how much)? If there is no reason you would want a concentrated position in XYZ, then sell it and make the appropriate investments for your goals. You could make a small concession to taxes, such as spreading the sale over a few years if that helps keep you in a lower bracket.

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