With the recent fall of Bear Stearns and the not too distant collapse of Enron, the concept of not holding all your eggs in one basket often gets mentioned. If you work for a certain company and own many shares of the company that have been acquired over decades of service you are putting yourself into a very precarious position! Scores of people who worked for Bear or Enron not only lost their ability to earn an income (their jobs), but they may have simultaneously lost the bulk of their retirement savings – a crushing blow to say the least.
Some people who own a large number of shares in a non-registered account may feel that they do not want to realize potentially significant capital gains even though they understand they are poorly diversified. Conversely, if the stock falls in value, your portfolio could be hit with some serious declines in value.
Enter the Equity Monetization Strategy. This strategy essentially allows you to sell your economic interest in your shares without having to dispose of them (physically or for tax purposes) until a later date, say five years from now. The share-owner needs to enter into a forward contract (a type of derivative) with a financial institution. The forward contract allows you to set a sale price for your shares for some time in the future.
Since you now know what you will be able to sell your shares for at a certain point in the future (even if the actual value of the shares goes down by then), you can then pledge your existing shares as collateral for a loan that can be used to create a diversified portfolio. The interest on this loan would be tax deductible to boot.
You have deferred the realization of taxes (for years if you so decide), and have created a more diversified investment portfolio in the meantime. The tradeoff is that you will have given up some upside potential by locking in the future sale price. (Conversely, if the securities go down or pull an Enron – you’d be laughing.)
If you like this blog, you might like my book:
RRSPs: The Definitive Book on Registered Retirement Savings Plans