This week, my Co-Chief Investment Officer, Summit Puri, Tim Hilterman, CFP®, and I were able to spend about an hour with Meb Faber, who was in town for the Financial Planning Association All-Ohio Symposium, talking markets, US vs. International valuations, the incompetence of CALPERS, and 351 ETF conversions. Admittedly, Section 351 ETF conversions are not very well known. At the above-mentioned FPA All-Ohio Symposium, only about 5% of Financial Advisors admitted to having knowledge of this unique part of the tax code. Thankfully, I have had brief exposure to the strategy recently, while working through the material for my newest designation, I'm working on, the Tax Planning Certified Professional (TCPC™️) through the American College of Financial Services.

Fortunately, some people amass great wealth in a single stock. With concentration can come quick and large gains. However, the same can be said in reverse. With great concentration, great wealth can be lost. Take a look at the chart below. As of the beginning of May, the S&P 500 is down 4.42% this year; however, you can see there are many employees and investors of Kohl's, Abercrombie & Fitch, Neogen Corp, & Nabors Industries that are having a much worse year than you, as it relates to their wealth. For many of those stocks, a nearly 50% loss. Ouch! The reality is that it could be any company, in any given year. Perhaps these names will rebound, but to the extent they don't, the investors and owners of these stocks could really have benefited from the section 351 ETF conversion.

At Whitaker-Myers Wealth Managers, we understand the challenges faced by investors holding significant positions in a single stock—often due to stock options, RSUs, ESPPs, or ESOPs. While such holdings can be lucrative, they also expose investors to substantial risk. As Dave Ramsey advises, limiting any single stock to no more than 10% of your net worth is prudent to maintain financial stability.

The Dilemma of Concentrated Stock Holdings

Holding a large position in one stock can be risky. Market volatility, company-specific issues, or industry downturns can significantly impact your wealth. Diversifying your portfolio is essential to mitigate these risks and ensure long-term financial health.

Introducing Section 351 ETF Conversions

Section 351 of the Internal Revenue Code offers a solution: it allows investors to transfer appreciated securities into a newly formed corporation (such as an ETF) in exchange for shares, without triggering immediate capital gains taxes . This strategy enables you to diversify your holdings while deferring tax liabilities.

For example, let's say you hold $500,000 of Apple Stock. You would like to diversify this holding into a broader investment structure like an ETF can provide. You could make a contribution to the Section 351 ETF being created. You'll get shares back of the ETF, which had many contributions from many different investors, like yourself with different concentrated stock holdings. After seven days, the investments in the ETF are sold and reinvested in a diversified manner, but because this was done in an ETF wrapper, you realize no tax gain. When you decide to sell the investment (which would most likely be in small pieces over time), at that point, you'll realize the tax gain. Therefore, it's important to remember that you are not eliminating your tax liability because of the exchange, but eliminating your single stock risk. To quote Ben Franklin, "Nothing is certain except death and taxes."

Benefits of Section 351 ETF Conversions

• Tax Deferral: By transferring your concentrated stock into an ETF structure, you can defer capital gains taxes, allowing your investments to grow uninterrupted.

• Diversification: The ETF structure provides exposure to a broad range of assets, reducing the risk associated with holding a single stock.

• Liquidity and Flexibility: ETFs are traded on major exchanges, offering liquidity and the ability to adjust your investment strategy as needed.

Eligibility Considerations

To qualify for a Section 351 exchange, your portfolio must meet specific diversification criteria:

• No single security can constitute more than 25% of the total value.

• The combined value of the top five securities must not exceed 50% of the total portfolio .

If your holdings are too concentrated, alternative strategies like exchange funds might be more appropriate.

Aligning with Dave Ramsey's Philosophy

Dave Ramsey emphasizes the importance of diversification and cautions against overexposure to single stocks. He recommends investing in a mix of growth, growth and income, aggressive growth, and international mutual funds to achieve a balanced portfolio . Section 351 ETF conversions align with this philosophy by facilitating diversification and promoting long-term financial stability.

Taking the Next Step

If you're concerned about the risks associated with a concentrated stock position, consider exploring a Section 351 ETF conversion. This strategy can help you diversify your portfolio, defer taxes, and align with sound investment principles. Contact our Chief Financial Planner, Tim Hilterman, CFP® by clicking this link.

At Whitaker-Myers Wealth Managers, we're here to guide you through this process and tailor a strategy that fits your financial goals. Contact us today to learn more about how we can help you achieve a more balanced and secure financial future.