I have $3 million invested in stocks like Tesla and Apple and I want to diversify my portfolio, but if I sell now, I will lose money

Personal Finance

Published: November 28, 2024 1:41 pm

Last Updated: December 27, 2024 2:32 pm

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24/7 Wall St. Key Points:

Growth stocks can be a great way to build wealth, but it’s essential to diversify beyond regular growth stocks.
Diversifying isn’t always straightforward, though, especially when high taxes are thrown in the mix!
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Recently, I read a Reddit post by a FAANG software engineer that highlights a dilemma many high-income tech workers face. With a net worth of over $3 million invested in a few tech stocks—Tesla (NASDAQ: TSLA), Apple (NASDAQ: AAPL), Amazon (NASDAQ: AMZN), and RSUs—the engineer is grappling with diversification.

Of course, as a tech engineer, he believes in tech stock. Plus, selling would trigger a hefty tax bill, particularly in California, where he lives (where short-term capital gains tax can reach 55%).

The question comes down to: Is it worth paying a seven-figure tax bill to diversify, or should they stay the course and avoid potentially losing out on the tech bull market? Here are my recommendations:

Why I Would Diversify

Diversification is a key to financial planning. Otherwise, your portfolio is just too prone to collapsing at the slightest stock market winds. This is especially true when your wealth is tied up in growth stocks, which tend to be more risky, anyway.

Diversification is vital for a few reasons:

Risk reduction: A concentrated portfolio, even in top tech stocks, carries high risk. Diversifying can protect against market downturns or sector-specific issues.
Portfolio balance: Recollecting funds into other asset classes can provide stability and ready returns over time.
Long-Term Stability: While tech stocks are thriving, markets are unpredictable. A more balanced portfolio prepares you for future volatility.

However, taxes complicate matters. It also doesn’t make sense to suddenly sell all the stocks and pay a high tax rate! Let’s take a closer look at this tax hurdle.

The Tax Hurdle

The engineer’s primary concern is the tax burden of selling, especially short-term capital gains taxes on Tesla stock.

There are a few different options he could employ:

Short-Term vs. Long-Term Gains: Waiting to sell Tesla stock until it qualifies for long-term capital gains (after holding for over a year) could reduce the effective tax rate from 55% to almost 40%. This would significantly reduce the overall tax liability and is a common strategy to help lower your taxes.
Consider Partial Sales: Selling in phases, focusing on long-term holdings first, can help manage the tax impact while beginning diversification.
Offsetting Gains: Exploring ways to offset gains through tax-loss harvesting or charitable giving can also help lower the overall tax bill.

Rate Type	Short-Term Gains (Ordinary Income Rates)	Long-Term Gains (Over 1 Year)
Federal (Top Bracket)	37%	20%
Net Investment Income Tax (NIIT)	3.8%	3.8%
California State Tax (Top Rate)	13.3%	13.3%
Approx. Total	~54% to 55%	~37% to 38%

My Recommendations

If I were in this FAANG engineer’s shoes, I’d recommend a phased diversification strategy to balance risk and tax efficiency. Here are some steps I would take:

Prioritize Long-Term Holdings: Identify which stocks are already eligible for long-term capital gains (held for over a year). These will incur a lower tax rate (~40% in California). Start by selling off a portion of these long-term holdings and begin to diversify without triggering a higher tax rate.
Manage Short-Term Gains Strategically: Wait whenever possible on stocks with short-term gains until they qualify as long-term capital gains.
Diversify Gradually: You don’t have to diversify all at once. Instead, I would diversify gradually. Use funds from sales and new investment cash to buy stocks in different sectors. You can keep a reasonable percentage (around 40%) in tech stocks you feel confident in.
Optimize Tax Efficiency: If you have any underperforming investments, sell them to offset gains and reduce your overall tax bill.
Consult a Financial Advisor: I do not have this poster’s specific financial information. Working with a qualified financial advisor or tax specialist can help you make decisions for your specific financial situation.

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