Maxwell: I'm always aware that, financially, anything can happen at any time that could just bleed you off your savings and what you have.
Jamie: Meet Maxwell, a father of two in his early 50s.
Maxwell: My family's aware that I can be quite conservative or frugal. But if something should happen, I don't have an excuse. They're going to be like, "Well, why were you spending so much? You are the smart one. You should have planned that something bad could have happened." So, that's always in the back of my mind.
Jamie:
Maxwell has a reason for being so frugal, and it can be traced back to his childhood.
Maxwell:
I grew up in what I would consider lower middle class, lower, lower, lower middle class. So I grew up with everyone around me, like my classmates and friends, definitely always having more than I had, and knowing not to ask my parents for certain things because I was aware of their income, and what they made, and what they could afford.
Jamie:
Maxwell has worked hard to ensure that he could provide what his family needs and then some. So, how does that leave Maxwell feeling about money and personal finances now?
Maxwell:
Confident with a healthy dose of anxiety.
Jamie:
I think that's a great answer, and it's why financial stability has always been important to Maxwell, because of how it impacts his family.
Maxwell:
To put myself in a better situation, to aggressively make more so I can provide more so that any child that my partner and I bring into the world would have everything that we didn't have.
Jamie:
But it wasn't just about making more money, it was about saving more. For instance, when his youngest son was still in preschool, Maxwell and his wife were already putting aside money for his college tuition.
Maxwell:
You found a way to pay for daycare, so make it a lifetime commitment. The child is no longer in daycare, but there's going to be future expenses. So we just diverted those funds to a 529 plan, and just set it and forget it.
Jamie:
If you're unfamiliar, 529 plans are a type of investment account to help save for education costs, like college. Contributions grow tax-free, and in some states you may get a tax deduction for some amount of contribution. They can also offer potential estate tax benefits. I've put a link in the show notes if you'd like to learn more about 529 plans. But Maxwell isn't only concerned about his kids, who are fully grown now. He has a daughter in her early 30s and a son about to start college. He's thinking about the family that hasn't even been born yet.
Maxwell:
Generational wealth is important, and it has to start somewhere. Don't go, "Oh, that's nothing. That's a drop in the bucket." If you have that mindset then you'll never build anything. You should leave something behind, build it up, and then leave it for the next generation.
Jamie:
That's where we'll start today. I'm Jamie Roô, and welcome to What Should I Do With My Money?, an original podcast from Morgan Stanley. We match real people asking real questions about their money with experienced financial advisors. Here at Morgan Stanley, we work with a range of clients. Some are experienced investors, others are new to working with a financial advisor. On this show, you'll get a front row seat to hear what these initial conversations are like, and get answers to some of the questions you might have yourself.
Maxwell has done quite well for himself and his family. He's amassed over $1 million in his company's stock, but he worries that his portfolio isn't diverse enough. Even though his company's stock has consistently performed well until now, should anything go wrong, he would take a huge hit. So, how should he diversify without incurring large capital gains taxes? Maxwell also dreams of building a legacy of generational wealth for his kids and descendants, but he doesn't know how to get started. To shed some light on Maxwell's concerns, we have Evan, a managing director and wealth advisor joining us from our New York office. When he was still a kid, Evan got a taste for investing when a relative gave him an unexpected gift.
Evan:
I would say I became interested in investments back in middle school when I was gifted shares of a stock for my birthday. I think that gift of stock led me into an early education about the importance of saving, investing, and the power of compounding from such an early age. When I say compounding, I mean compounding of wealth, education, and disciplined behavior.
Jamie:
Why do you think it's important for families to talk about finances, estate planning, investing, all the things that you've built your career around?
Evan:
When I started at a job out of college, I partnered up with two veteran financial advisors. A lot of the clients that my partners had worked with were thinking about distribution of wealth for their families, and protecting wealth for generations, and instilling those values. Each family is so different, and money and family is so personal, so there is no one size that fits all.
Jamie:
It's with that perspective that Evan kicks off the conversation.
Evan:
Maxwell, it really is a pleasure to meet you. It sounds like your parents had a very big impact in the way you think about wealth, and your upbringing, and the values that you want to share. So, what is the most important thing to you to get out of this conversation today?
Maxwell:
A strategic way to at least cut in half my allocation of my company-owned shares into other vehicles that have similar ROI while minimizing my tax liability.
Evan:
Got it.
Maxwell:
But I'm aware, and I've been told by others, that I'm too heavily vested in my employer's stock plan or shares of that company. My overall portfolio is probably a third of that, which definitely not healthy. If the market shifts... The stock dropped $20 recently, so that was a huge swing because so much has concentrated there, and I know I have to bleed it off. But especially with the ESPP, I got it at the 15% off, and then I got it so many years ago.
Jamie:
ESPP stands for Employee Stock Purchase Plan. It's a program that some companies offer their employees that typically enables them to buy shares of the company's stock at a discounted price.
Maxwell:
It's just like, if I liquidate that, I know there's long-term tax implications. But, what is the best way to do so? I feel like the ESPP is what I should target first versus the ones I got from RSUs.
Jamie:
RSU stands for Restricted Stock Unit. These are also shares of company stock. But rather than ESPP shares that employees can buy, RSUs are granted to the employee as part of their compensation package. Maxwell thinks he should sell the ESPP units, the ones that came at a discount, first.
Maxwell:
Maybe, maybe not. I'm just making those assumptions. So I just need that guidance, because I'd rather someone say, "Hey, do this. Here's what you need to do," and I need to do it sooner rather than later, instead of just sitting there in love with it because I keep seeing how much it goes up.
Evan:
Right. I think it is important to review this with your financial advisor and tax advisor. But in summary, RSUs, you can sell when they vest, as long as it's in an open trading window that may be relevant to your role in firm. ESPPs, you need to wait typically two years from the initial grant date and one year from the vest date to get the max tax benefit. So, it is important to review each one of these and make sure you're making the decision on which lot you're selling, and which one that is in your best interest.
You mentioned you have about 30% in company stock. The way that we typically recommend a client to reduce that is to do it in a systematic fashion. But, it's very hard behaviorally to sell a stock that continues to go up. I'm sure that also impacts the percentage you have. Even if you did sell some shares and it continues to go up, it still maintaining to be a high percentage. So, typically what we like to do with clients is map that out and understand where you are today and where we're trying to get to, let's say down to 10% or 15%, and then do that over a period of time in a systematic fashion. So, that's usually what we do, we would map that out. As a financial advisor, one of the things that we can do is take the emotion out of it and do that for you on a regular basis.
Maxwell:
Okay. No, that makes sense.
Evan:
Now, one of the things you mentioned, which I think is extremely important, is the tax implications of this. That has to be modeled in as well. Do you have another portfolio outside of this company stock that are even in non-retirement accounts?
Maxwell:
Yes.
Evan:
Those, I believe are in exchange-traded funds, indexes?
Maxwell:
Yes, there's a portion that's in Mutual, the 529 and two ETFs. Oh, and the fifth one would be a brokerage account that is comprised of different type of blue chip stocks.
Evan:
Right. We would build that financial plan for you, and we would break out what assets you have in non-retirement accounts because that's the area where tax implications are most impactful right now, and might even be changing your behavior of selling down some of your company's stock.
Jamie:
If you've listened to this podcast before, you've probably heard an advisor suggest doing a financial plan, that's because a financial plan is an important first step that essentially creates a blueprint for everything that comes next. In Maxwell's case, it would inform how to set up his accounts, and determine the best way for him to diversify his company's stock.
Evan:
Something you should consider in your situation is tax harvesting, which is matching capital gains and losses against each other, not once a year or periodically, but throughout the year. A very important consideration when working with a financial advisor, and one to confer with your tax advisor on to make sure everything is aligned. An example of this would be, throughout the year, if one of your investments in your portfolio is down and you're able to capture a realized loss, and buy another investment that has a similar investment thesis in correlation, you can sell that position, buy a new position, and in that situation you've captured a loss while maintaining your investment strategy. There's something called direct indexing. Are you familiar with direct indexing?
Maxwell:
No, I am not.
Evan:
Okay. Direct indexing, and I'm sure you're familiar with the S&P 500-
Maxwell:
Yes.
Evan:
Or the Dow Jones Industrial Average.
Maxwell:
Yes.
Evan:
Well, those are indexes. As an investor, you have the ability to buy that index at a very low cost, gaining exposure to that index. When you buy an index in an ETF, you're owning in that ETF, and let's use the S&P 500 as an example, all 500 stocks within one index, but it's one position.
Jamie:
Evan is talking about an exchange-traded fund, which is a type of investment that gives you exposure to many different securities in one fund. ETFs are generally low-cost and tied to a specific index, for example the S&P 500. Maxwell mentioned he has some ETFs, which can be helpful to provide diversification. But when tax efficiency is a priority, sometimes it's worth considering other strategies, like direct indexing.
Evan:
Direct indexing is the ability for you to own the individual positions within that index outright. What direct indexing does is, it owns 300 stocks, 350 of that 500. Because we do know every day, not all stocks are going up. Matter of fact, even in a year like this, or last year, there were a lot of positions that were down on the year. What we're able to do is sell positions that are at losses, and swap into other positions within the S&P 500. So the ultimate goal is to get the exact same performance as the S&P 500, but throughout the year, perhaps even capture losses.
Typically, as we're building a portfolio, that is a tool that we often use for people that have concentrated positions in company stock. We'd employ both a systematic sales process of selling that stock, and then also coupling it with a direct indexing strategy that hopefully can provide realized losses to offset against capital gains. The systematic approach of selling the stock is something that is happening every month, but it's regularly reviewed with you throughout the year, making sure that you are keeping cash aside to be able to pay taxes down the road, but also just so that there isn't a surprise.
Jamie:
Maxwell knows intellectually that he needs to take some action to temper the risk of his large company stock position. But emotionally, there's something holding him back, whether apprehension about paying taxes on his gains, or the fear of missing out on future gains.
Maxwell:
Some of those fears, whether they're rational or not, are inherent in me. I'm self-aware enough to know that it's blinding me from making the right decisions to just get out, because I'm like, "Oh, that's a lot of capital gains I have to pay," and it's just boiled over. It's almost $1 million worth of stock. It is a good problem to have, but it's just... As I'm saying it out loud I'm like, "Oh, you're such an idiot."
Evan:
No, I certainly would not say you're an idiot. What you're sharing is very rational, and it's hard to do. Employing disciplines like this to reduce a concentrated position in something that continues to go higher is hard to do. Obviously, the reason why you want to do that is because you understand the risk that it can fall, and it can fall precipitously.
Maxwell:
Yes.
Evan:
One of your main goals in life is to protect your legacy. You've built up the wealth. Is there anything else you're doing with that company stock? Is it all in your name? Do you gift those shares to children, or to trusts, or anything?
Maxwell:
I have a couple godkids, and I want to gift them... I plan to do that this year, to give them some shares of the company stock. I think it's just relatively easy for me to contact them and say, "Hey, I want to hook you up with something. I have a surprise for you," and take care of it that way.
Evan:
Okay. Okay. Understood. Yeah. Look, that's something to map out. Of course, when you do grant those shares to them, you're also granting to them the tax liability. So, it's something to factor in.
Maxwell:
That was the other thing too, how versed are they with taxes and such to say... I just don't want to give it to them and, all of a sudden, they're like, "Hey, wait a minute. I owe taxes. What did you do to me?" I don't know exactly how that works.
Evan:
Right, exactly. It's not a complete gift. There are considerations when choosing whether to give securities or cash to someone, and those factors include capital gains tax, what tax bracket they're in, what state they live in, these are all things to review with a tax advisor. But generally speaking, if someone is looking to gift money to a minor, or to the next generation, we often recommend that they gift cash because it's clean, not to burden them with some of these other considerations. Now, are you and your partner set for the future? What percentage of your money is for you, and what percentage of your money is for legacy planning?
Maxwell:
My wife and I do have a family trust. All of our accounts that I just talked to you about, they're in the family trust. The beneficiary for my 401k is the family trust. Yeah, we did that a good time ago.
Evan:
I'm glad to hear that you've done estate planning already. It's very important to continue to review it as time goes on, not only as your wealth changes, but also as laws change. Not only has your wealth grown, but things have changed. Have you had conversations with your son and daughter about what wealth means to you?
Maxwell:
We were in the car a couple months back and my son was listening to some artist, and there's a line about his kids, kids, kids, kids. I said to him, "Do you know what that means?" He was just like, "Yeah." I said, "What if I charge you and your sister with, whatever we leave you guys, you commit to increasing it by 25% for your kids?" He's like, "That sounds reasonable. That sounds fair." "Then the same thing for them, whatever you leave them, you charge them with increasing it by 25%, put their kids." He's like, "Yeah." He was like hip to the idea. He was really intrigued by it.
Evan:
I think this is a huge part of the conversation, being able to sit down with your children, and talk to them about investing, saving, and also what this money means to you. Are you currently gifting to them in any way right now?
Maxwell:
No. No, I'm not. When you say gifting, anything out of these investment vehicles, like siphon off anything and direct it their way?
Evan:
Yes. You and your wife each have the ability to, in a tax-free way, move either appreciated stock or cash from your personal portfolio, whether it's annually or semiannually, or whatever you guys choose, where you are giving them money every year, whether it's into an investment account or outright to them. I ask that because you and your wife each have the ability, in a tax-free way, to move in this year $18,000 each to each of your children. That number changes every year, generally higher as inflation grows, free of filing anything on a tax return.
Maxwell:
Just so I'm clear, so each child can get 36K?
Evan:
That's correct. I'm not recommending this. I think the first thing we have to do is a financial plan to make sure that you and your wife's goals are met. But ultimately, since your goal is to leave a legacy, it is something to consider. Now, when you are giving that money, it doesn't mean you have to give it to them in their own name. It could go into a trust for their benefit in the future. It's something that some clients do.
It gets money out of their estate, it gets them involved, and it makes sure that there's money there in a protected manner. The benefit of a trust is, it helps protect against creditors, predators, and potentially future ex-spouses. There's a trustee on that trust. That trustee can be someone you yourself trust, that are going to be there to invest it the right way and make sure the funds are used. So it's something that you might consider doing after you and your wife feel comfortable for yourselves, and something we can explore further.
Maxwell:
Oh, that's very interesting.
Evan:
I think at this stage right now, where you are, there's a lot that you could be doing it, but it all starts with that financial plan.
Maxwell:
Okay. Yeah.
Jamie:
Evan, so much useful guidance for Maxwell's questions, from tax-efficient tactics for diversifying his stock, to building a plan for generational wealth, of course, starting with that financial plan. Thank you so much for your time today.
Evan:
Yeah, absolutely. Maxwell, thank you for sharing some of the goals that you're thinking through, and also about your family. It was great meeting you.
Maxwell:
All right. I appreciate it.
Jamie:
Maxwell, how was that for you?
Maxwell:
Very informative, refreshing, and scary at the same time. Because I know it confirms that there's so much more that can be done. It can feel a little bit daunting at times, but I know from experience, once you get going, you feel a lot better once you get that process going. So, there's always steps. I know that it's never one thing and then you just forget about it. You have to keep working at it.
Jamie:
Was there anything that was surprising in the advice that Evan gave you today?
Maxwell:
I never considered, even at this age, having the kids set up their own trust. My daughter's a little different 'cause she's older, and she has her kids. But I never thought about the son who is still in school, doesn't have much of his own wealth, that he should have his own trust.
Jamie:
Right. What about all of the discussion around your stock position? Do you feel like you have a better sense of what you need to do now?
Maxwell:
Conceptually? Yes. The first thing being, taking the emotion out of it and being very systematic and clinical about the whole thing.
Jamie:
Well, thank you so much for joining us, and for being so honest and forthcoming about your situation. It was a pleasure to meet you.
Maxwell:
You're welcome. It was great having that conversation.
Jamie:
If you'd like a deeper dive on what was discussed today, or to learn more about direct indexing and financial planning strategies, come see us at morganstanley.com/mymoney. I'm Jamie Roô. Talk to you soon.
Disclosures:
This material has been prepared for informational purposes only. It does not provide individually tailored investment advice. It has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. Morgan Stanley Smith Barney LLC ("Morgan Stanley") recommends that investors independently evaluate particular investments and strategies, and encourages investors to seek the advice of a Morgan Stanley Financial Advisor. The appropriateness of a particular investment or strategy will depend on an investor's individual circumstances and objectives. Past performance is no guarantee of future results.
The 529 Plan Program Disclosure contains more information on investment options, risk factors, fees and expenses, and potential tax consequences. Investors can obtain a 529 Plan Program Disclosure from their Financial Advisor and should read it carefully before investing. Investors should also consider whether tax or other benefits are only available for investments in your home state 529-college savings plan.
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