Plot Twists in Financial Wellness: Capital Gains Versus Volatility

When clients hold highly appreciated investments, the decision to reduce risk is rarely straightforward. Selling can trigger meaningful capital gains taxes, while holding on can expose portfolios to volatility that may no longer be necessary to achieve long-term goals. This case study walks through a common planning dilemma faced by a fictional couple approaching financial independence, illustrating how different choices, holding, partially selling, or fully reallocating, can impact both portfolio outcomes and peace of mind. By exploring these tradeoffs, we aim to show how thoughtful financial planning helps clients move forward with clarity and confidence.

Tripp and Rose Rodin, both age 55, are making significant progress toward financial independence. They hold approximately $800,000 of appreciated stock in a taxable account, with roughly $200,000 of unrealized gains. While their portfolio has served them well, they are increasingly uncomfortable with the volatility created by several higher-risk positions.

Importantly, they no longer need to take this level of risk to reach their long-term goals. Seeking a second opinion, they asked a simple but common question:

Do we reduce risk now and pay capital gains taxes, or do we hold on and accept continued volatility?

As financial planners, our role is not to make decisions for clients, but to clearly illustrate the tradeoffs so they can make informed, confident choices. Below are three simplified options, each modeled with a hypothetical 20% market increase and a 20% market decline. (For illustration purposes, we assume a 20% long-term capital gains tax rate and a 4% return on bonds.)

Option 1 – Keep it.  

In this scenario, Tripp and Rose decide to hold their entire stock position to avoid realizing capital gains.

• 20% Market Increase:
  Their $800,000 grows to $960,000. However, their unrealized gain has now increased from $200,000 to $360,000, further compounding future tax exposure.

• 20% Market Decline:
  Their portfolio declines to $640,000. While no taxes are triggered, the drawdown raises an important question: how long will it take, and how much volatility must be endured, to recover?

This option preserves tax deferral but maintains full exposure to market swings.

Option 2- Sell half.

Under this approach, Tripp and Rose sell $400,000 of stock and reinvest the proceeds into bonds earning a conservative 4%. The estimated capital gains tax due is $22,800.

• 20% Market Increase:
  The remaining $400,000 in stocks grows to $480,000. The bond allocation grows to $416,000.
  Total portfolio value: $896,000
  Net of taxes paid: approximately $873,000
  Net return: approximately 8.2%

• 20% Market Decline:
  Stocks decline to $320,000, while bonds still grow to $416,000.
  Total portfolio value: $736,000
  Loss: approximately 8% gross, approximately 10.9% net of taxes

This option meaningfully reduces volatility while still allowing for market participation.

Option 3 – Sell all.

In this scenario, Tripp and Rose fully exit the stock position, realizing a capital gains tax of approximately $45,600, and reinvest entirely into bonds earning 4%.

Regardless of market direction:

• Portfolio grows to $832,000 (4% gross return)

• Net result after taxes: approximately -1.7%

This option eliminates equity volatility but comes with an immediate tax cost and lower growth potential.

Putting it All in Context

Strategy	Equity Exposure	Capital Gains Taxes Paid	20% Market Increase	20% Market Decrease	Volatility Profile
Option 1: Keep All Stock	100%	$0	$960,000	$640,000	High
Option 2: Sell Half	50%	$22,800	$873,000 (Net)	$736,000 (Net)	Moderate
Option 3: Sell All	0%	$45,600	$832,000 (Net)	$832,000 (Net)	Low

Assumptions: $800,000 taxable portfolio, $200,000 unrealized capital gains, 20% capital gains tax, 4% bond return

These examples are intentionally simplified and based on a fictional client. In real-world planning, we would evaluate additional factors, including:

• Capital loss carry forwards

• Broader asset allocation

• Concentrated stock risk

• Options strategies to manage downside

• Household-level risk exposure

• Current market conditions and cash-flow needs

There is no universally “correct” answer. We have clients who have chosen each of these paths, and variations in between. What matters most is understanding the tradeoffs and aligning the decision with what is most important to you.

If volatility keeps you up at night, tax deferral alone may not be worth the emotional cost. If minimizing taxes is your top priority, you must be willing to tolerate uncertainty. The right answer is the one you can live with confidently.

At the end of the day, these are your assets and your goals. Our job is to help you understand your options so you can choose your path with clarity and intention. If this case study resonates, we welcome the opportunity to help you think through your own planning decisions.