Investment managers preach the value of diversification on a regular basis. It is one of the fundamental principles in designing an investment strategy for someone. As advisors, we know we should never ‘put all your eggs in one basket.’ This works really well in many cases. It is why investment funds are so popular. You can buy units in a managed fund solution and achieve diversification with a single transaction because the performance of your investment relies on the underlying securities in the fund, and as we mentioned to start out, all fund managers will have their holdings well diversified. But what happens when you hold a large position in a single stock? Maybe you have a share purchase plan where you work or got a ‘hot tip’ on a stock that worked out (not always a great strategy, but sometimes luck shines on you). Now, you hold a large investment without diversification and face tax consequences if you try to move towards a more diversified portfolio. What are your options now? Read on, and we will discuss this problem and a potential solution.
Let’s Set the Stage….
If you are Canadian and of a certain vintage, you no doubt recall a couple of Canadian-owned businesses that were incredible success stories over the years. One such example, Nortel Networks, was a Canadian tech company where, in the year 2000, this single company’s value made up 35 percent of the value of the TSX 300 Composite Index. On August 1, 2000, Nortel Shares were worth $815.00; on July 1, 2002, that price was $9.70 a share. Many employees of Nortel were given stock options and were able to acquire large holdings in the company for what was effectively a discount when they purchased the shares. Without getting into too many tax details here, these options often carried something called ‘phantom income’ with them and could create quite a tax bill when and if they were sold. With this tax bill looming and the belief that the company they worked for was well-managed and would continue to grow, many employees held on to their shares and counted on them as a big part of their retirement plans. Unfortunately, the belief in the leadership of the business wasn’t well founded, and through a series of poor decisions and choices by management, Nortel fell apart to the point that they eventually went bankrupt, and the company was sold off for parts. With the shares essentially worthless, many people now faced the hard reality of their financial plan being decimated because of the failure of one single company.
A more recent example would be Research In Motion, the creators of BlackBerry. In June of 2008 BlackBerry stock had a value of $147.55 a share, the average price for the past 52 weeks as of June 2024 is $3.71. Again, many employees were given the opportunity to invest via stock options and ended up in a position where they were massively overweight with one particular company in their investment portfolio.
I get it that both of these examples are tech companies, and any seasoned investor knows that tech is a very volatile sector in which to invest. The thing is that many people in Canada were overexposed to these companies because they were employed by them, and one of the perks of employment was the share purchase plan. These ‘stock options’ allowed them to make investments in shares of the company they worked for easily and, seemingly at the time, in a cost-effective way. Without a proper financial plan, just taking advantage of the reduced prices and one of the benefits from work, many people had stock ‘portfolios’ that only held one company, that being the one they worked for.
So the stage is set. You are an employee of a company, and you hold a stock portfolio of a single company, the one you work for, where there are significant tax implications if you sell any of the shares to try and diversify your holdings. What do you do? What if we told you that there is a solution where you could diversify your portfolio and do so in a manner that doesn’t trigger the taxes right now, instead allowing you to defer them into the future? Is that a plan that could interest you?
The Strategic Partnerships You Need
At Strata Wealth & Risk Management, we pride ourselves on offering our clients the most comprehensive set of planning tools available to help people build their wealth effectively and to help them spend their savings in a way that maximizes tax savings. This is what drives us to continuously be on the lookout for different partners that have offerings that provide a strategic advantage for our clients. One of these partnerships can help you if you find yourself in a situation where you are faced with a stock portfolio that isn’t diversified properly, and you would like to make that happen without triggering capital gains. Now, I know you love it when I talk about tax rules to you, so did you know that there is a provision in the Income Tax Act called a Section 85-1 rollover that allows for the tax-deferred rollover of shares in one Canadian Corporation for shares in another Canadian Corporation? See what you can learn if you read the Income Tax Act. Or just wait for someone else to read it and then have them tell you how it can benefit you. What? Tell you more? Why does this matter to me? Read on and find out.
Through our continuous search to be able to offer the best solutions to our clients, Strata Wealth & Risk Management has built a relationship with a financial company that offers a share exchange program that fits into the Section 85-1 rollover rules. What this means is that we facilitate a transaction where you exchange your stock portfolio, which is replaced with a diversified portfolio of managed investment funds. The transaction takes place while maintaining the original cost base of your stock portfolio, so it is not going to trigger any capital gains at the time that you make the move. You will now have access to a full menu of investment selections that can include fixed-income plans and equity funds, allowing you to reduce the volatility of your investment plan while you diversify your holdings as well. Imagine being able to take a portfolio of a single stock that has been built up through an employee purchase plan and transfer it into a managed investment solution that is made up of 60 different companies, reducing the risk in your investment plan significantly without triggering taxes with the transaction. This sounds too good to be true; at Strata Wealth & Risk Management, we can help you do it.
Work with Strata Wealth & Risk Management
Now remember, this is tax-deferral, so at some point in time, you will pay the capital gains that have accumulated in the plan. The key thing to think about, though, is that diversifying your investment holdings is key to their long-term success. You need to understand something, though. If we consider the Nortel example again, if you were holding a large amount of a single stock that had such a high value, would the idea of being able to trade it in and diversify your investment be appealing to you? This is actually a hard question to answer, and the reason is that recency bias is hard to overcome. Recency bias is your brain favouring what has happened recently over what has happened over the long term. So, way back in the year 2000, would your brain have allowed you to get out of Nortel stock, having seen it increase in value so rapidly over a short period of time? This is why you work with a financial advisor. At Strata Wealth & Risk Management, it is our job to be the impartial third party that works with you to overcome the tight distortions to which we are all susceptible. Right now, you may be thinking, ‘I came here for a financial plan tip, not a psych 101 lecture,’ but you need to know this is what a good financial advisor will do for you. We are the voice of reason that helps you weather the storm when markets are volatile and manage your expectations when growth seems to be easy and that it will never end.
Conclusion
Take the time to sit back and ask yourself, has your current financial advisor ever suggested a strategy like this? If the answer is no and you have a stock portfolio where, this type of move would help you have a couple of options. The first would be to take this article to whoever you work with now and ask them if they know what this is and if they can do it for you. The other option is to contact the team at Strata Wealth & Risk Management and have them review your current situation and see if it is a move that makes sense. We have the tools in place to help with complicated transactions like Income Tax Act-supported tax-deferred rollovers, as well as a comprehensive planning process where we work with clients to determine what their goals are and constantly strive to find partnerships where we can make achieving your goals easier. The choice is yours; call us today and arrange a time to talk with one of our advisors.
