Most advice on diversification assumes you’re starting from cash, or from a portfolio that’s already spread across dozens of holdings. Add money to different asset classes, rebalance once a year, and you’re done. That advice works fine until most of your net worth is sitting in one stock, at which point “just diversify” could end up being more expensive than useful because of capital gains tax.
This guide covers how to diversify your portfolio, and what to do when one position has grown so large that selling it would trigger a tax bill big enough to make you think twice.
Why diversify your portfolio
Diversification spreads your money across enough different holdings that no single company, sector, or event can do lasting damage to your net worth. It doesn’t eliminate risk, but it trades company-specific risk (the kind that comes from one business having a bad year) for market-wide risk, which is generally smaller and more predictable.
How most people diversify their portfolio
For a portfolio that isn’t dominated by a single stock, a handful of well-established methods do most of the work.
These methods share the assumption that you can freely buy and sell without any one trade being disruptive. Rebalancing a portfolio where the largest position is 4% of the total is a routine adjustment. On the other hand, rebalancing a portfolio where one stock is 60% of the total is a different problem entirely.
What to do if your portfolio is concentrated in one stock
A concentrated stock position is generally defined as a single holding that makes up more than 10% of your portfolio. It’s a common outcome of stock compensation, an early equity stake, or simply holding a winner for years without trimming it.
A concentrated portfolio comes with risks, so the common suggestion is to diversify. You sell some of it and reinvest in a different asset. This diversification works perfectly well. But if your portfolio includes a significant amount of unrealized gains, it won’t be cheap because the IRS wants its share of your gains.
Why selling to diversify can trigger a large, immediate tax bill
If your concentrated stock has appreciated significantly, most of its current value is unrealized capital gain. Selling converts that gain into a tax bill the same year, and for a large, long-held position the number can be substantial enough to change whether diversifying is even worth it on paper.
Holding the position keeps you exposed to concentration risk, but selling it hands a large share of the gain to the IRS instead of your future portfolio.
Neither option is clearly better on its own, but you have a third option.
Diversifying without selling: exchange funds
An exchange fund lets you contribute your concentrated shares to a pooled fund alongside other investors. In exchange, you receive shares of the fund, which by design holds a diversified basket of stocks rather than any single company. Because it’s structured as an exchange rather than a sale, no capital gains tax is due at the time you contribute.
To be clear: your tax bill is deferred (not eliminated). The money that would have gone to taxes keeps compounding in the fund instead. Compared with selling outright, an exchange fund gets you the diversification immediately without the upfront tax hit.
The tradeoff is time. To get the tax benefit, you generally need to stay in the fund for seven years before withdrawing a diversified basket of stocks, at which point your original cost basis carries over. Contributions are also limited to accredited investors, which for most people means individual income over $200,000 (or $300,000 jointly) in the last two years, or a net worth over $1 million excluding your primary residence.
Ready to do something about your concentrated portfolio? Get started sooner rather than later, since the tax savings from deferral compound the longer the money stays invested.
Other approaches you should consider
An exchange fund isn’t the only way to manage a concentrated position without an immediate sale. Depending on your situation, these are worth thinking about, too:
- Direct indexing. You hold the individual stocks that make up an index directly rather than through a fund, which creates opportunities for tax-loss harvesting elsewhere in the portfolio to offset gains as you gradually trim the concentrated position.
- Gradual multi-year sales. Selling a fixed percentage of the position each year, rather than all at once, spreads the tax bill across multiple tax years and lets you manage which bracket each year’s gain lands in.
- Charitable and estate strategies. Donor-advised funds and certain trust structures can reduce or eliminate capital gains tax on shares you intend to give away or pass on, though they come with their own tradeoffs around control and timing.
None of these is universally better than the others. Which one fits depends on your liquidity needs, your time horizon, and how much of the position you actually need to reduce.
How to diversify your portfolio without the tax bill
Every situation is different, and the right mix of these strategies depends on your income, your tax bracket, and how soon you might need liquidity. If you’re sitting on a concentrated position and want to see whether an exchange fund fits your numbers, find out if you qualify for the Glidepath fund.
]Frequently asked questions
How do I diversify my portfolio if most of my wealth is tied up in one stock?
Selling the position outright triggers capital gains tax on the full appreciated amount, which can eat a third or more of its value before you reinvest anything. An exchange fund lets you swap the concentrated shares for a diversified basket without selling, deferring the tax bill instead of paying it upfront, typically in exchange for a seven-year holding commitment.
What is the fastest way to diversify a concentrated stock position without selling?
An exchange fund is generally the fastest option, since you’re diversified as soon as your shares are contributed to the fund rather than waiting years for a gradual sell-down. The tradeoff is a multi-year holding period before you can withdraw the diversified shares with the tax deferral intact.
How much of my portfolio should be in one stock?
There’s no exact number and it depends on your risk tolerance and financial situation. Having said that, most financial planning guidance suggests keeping any single stock under 10% of your total portfolio. Above that threshold, a meaningful decline in that one company can do outsized damage to your overall net worth, regardless of how strong the company looks today.
