In our latest episode, Meg brought in a recent client question on whether or not to join an exchange fund, which sparked an interesting conversation.
Exchange funds are often presented as a way for people with a high concentration of one stock to simultaneously diversify into multiple stocks without paying taxes at the time. Sounds great, right? While exchange funds have their place, it’s not quite so simple.
The Cons of Exchange Funds
While exchange funds allow you to diversify without the taxes, they come with some significant downsides, including:
Exchange funds are predominantly limited by industry. For instance, if you had concentrated stock in a tech company like Airbnb and were invited to join an exchange fund, it would likely include multiple tech companies like Amazon, Meta and Google, but there would be no diversification into different industries.
In order to make a move to an exchange fund worth it, you’ll likely want to keep your money in it for at least seven years, which means those assets will be illiquid for at least that long.
Exchange funds usually consist of at least 20% questionable real estate investments that don’t stand on their own. Real estate can be a great investment, but the loose ends they pull together for exchange funds typically aren’t a net gain.
Moving from a concentrated position to an exchange fund may sound nice, but it actually increases the complexity of your financial situation. In our experience, simplicity is the way to go when it comes to finance.
Our Recommendation: Simply Sell
When clients want to get out of a concentrated position, we typically counsel them to just sell the stock, pay the taxes on it, and then invest in a more diversified portfolio. While exchange funds may keep you from having to pay taxes now, you will have to pay taxes on your stock positions eventually. Simply selling gives you access to the money now so you can use some on current needs and the freedom to invest the rest however you want.
A Couple Other Options
If you prefer to keep the stock while still gaining protection, you could try an option called a “put,” which says that if the stock ever dropped below a predetermined amount, the company you got the stock from would be required to buy it. You could also add a “call” option that says you will sell if it ever rises to a certain number. Keep in mind, options can get pretty complex and if you sell the wrong type of shares, you could incur a tax penalty.
You’ll want to keep these facts in mind if you are ever invited to an exchange fund. Everyone’s financial plan is different because no two people have the same financial needs and goals. The best decision for you depends on your goals and values!
Ready to learn more?
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Stone Steps Financial
Money can be confusing—but it doesn’t have to be. When you’re able to understand the complexities, you can make better decisions to improve your daily life. Are you ready to align your money with your ideal life? Connect with us at Stone Steps Financial.
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