Executives and founders enriched by the tech stock boom are increasingly recognizing the risks of having a substantial portion of their net worth tied to a single stock. Financial advisors recommend a diversification strategy, often suggesting that no more than 10% of a portfolio should be based on one asset. This approach aims to balance risk and opportunity for investors.
For those looking to diversify, selling long-held stock can incur significant capital gains taxes. One alternative is contributing shares to an exchange fund, or swap fund, which pools shares from multiple investors. Participants receive a partnership interest in the fund and, after a lock-up period—typically lasting seven years—can redeem their shares for a diversified selection of stocks. Exchange funds, popular since the 1970s, have seen a resurgence due to favorable market conditions and increased equity compensation offered by tech firms.
These funds generally allocate around 80% of their assets to stocks, aligning with benchmark indexes, while the remaining 20% is invested in non-securities, often real estate. Investment professionals like Steve Edwards of Morgan Stanley observe that clients are increasingly viewing exchange funds as a viable strategy for wealth transfer, as they can minimize the unpredictable outcomes associated with holding individual stocks.
However, some advisors express caution regarding the rigidity of exchange funds. Scott Welch from Certuity argues that other strategies, such as collars or tax-loss harvesting, may provide more flexibility and liquidity without the lengthy lock-up period.
Why this story matters: Highlights the importance of diversification to mitigate risk for wealthy investors.
Key takeaway: Exchange funds offer a strategic option for those looking to balance their portfolios while avoiding capital gains taxes.
Opposing viewpoint: Some experts prefer alternative strategies over exchange funds due to their rigidity and the potential for illiquidity.
