Are you tired of the risk in your concentrated stock position, but hesitant to diversify because of capital gains taxes? Enter the Exchange Fund.

Exchange funds, also known as swap funds, allow investors to exchange their single-stock concentration for shares in a diversified fund, without having to sell their original stock and trigger capital gains taxes. This type of fund can be particularly useful for investors who have a large position in a single stock due to inheritance, employee stock purchase plans (ESPP), or stock compensation (RSU, RSA, ISO, NQSO).

The process of exchanging a concentrated position for shares in an exchange fund is called a stock swap. Investors contribute their shares of the concentrated stock to the exchange fund in exchange for shares in the fund that are diversified across a basket of stocks. The exchange fund then manages the diversified portfolio, potentially providing greater stability and reducing overall risk.

One of the key benefits of exchange funds is that investors can defer capital gains taxes on the sale of the concentrated stock. Because the exchange is structured as a swap, rather than a sale, investors do not trigger capital gains taxes. Instead, the tax basis of the original stock is transferred to the shares in the exchange fund. This can be particularly valuable for investors who have held the concentrated stock for a long time and have a low tax basis.

Another important consideration for investors interested in exchange funds is the 7-year holding requirement. In order to maintain the tax deferral on the original stock, investors must hold their shares in the exchange fund for at least 7 years. This can be a significant commitment, but it is designed to prevent investors from using exchange funds as a short-term tax avoidance strategy.

During the 7-year holding period, investors receive dividends and other distributions from the exchange fund, and the value of their investment may increase or decrease depending on market conditions. However, because the exchange fund is diversified across a basket of stocks, the overall risk is generally lower than a single-stock concentration.

After the 7-year holding requirement, the exchange fund distributes a basket of 30-50 individual stocks from different sectors to the investor. These stocks are part of the underlying exchange fund portfolio and are not chosen by the investor. The specific stocks included in the basket may vary depending on the fund's underlying stocks in the larger pool and market conditions.

It's important to note that exchange funds are not without risks. Like any investment, exchange funds carry the risk of loss and past performance is no guarantee of future results. Additionally, because exchange funds are typically structured as private investments, they may have higher minimums and/or fees than traditional mutual funds or ETFs. Investors should also consider the potential impact of the 7-year holding period on their overall investment strategy. Investors who need to access their funds before the end of the 7-year holding period may face liquidity constraints.

Overall, exchange funds can be a useful tool for investors who are heavily concentrated in a single stock and want to diversify their holdings without triggering capital gains taxes. The stock swap nature of the transfer allows investors to maintain their tax basis in the original stock while gaining exposure to a diversified portfolio. As with any investment, investors should carefully consider the risks and potential benefits of exchange funds before making a decision.

DISCLOSURES:

The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.

Generally, among asset classes, stocks are more volatile than bonds or short-term instruments. Government bonds and corporate bonds have more moderate short-term price fluctuations than stocks, but provide lower potential long-term returns. U.S. Treasury Bills maintain a stable value if held to maturity, but returns are generally only slightly above the inflation rate.

Asset Allocation may be used in an effort to manage risk and enhance returns. It does not, however, guarantee a profit or protect against loss.

The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.

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