The Ups and Downs of Company Stock
It’s a powerful scenario for many employees:
You’ve been promoted at your current company or taken an exciting new job opportunity, and as part of your new compensation package, will be receiving company stock. Wahoo!
Whether you have been granted stock through restricted stock units (RSUs), are buying stock through an employee stock purchase plan (ESPP), are receiving stock options (either ISO or non-qualified), or any other type of the equity compensation alphabet soup, the feeling of accomplishment is undeniable. Equity compensation can be a phenomenal vehicle for helping you to achieve your financial and lifestyle goals.
Employees receiving equity compensation often do not think about the inherent risk and swings that come with potentially being overconcentrated in their company. When you have an overconcentrated position, a vulnerability in your portfolio is created that could be damaging down the line. Let’s dig into what it means to be overconcentrated in your portfolio and why you should think about setting limits.
How Does Overconcentration Happen?
As employees grow their careers, it’s common for employers to offer company stock as part of their overall compensation package. Stock compensation programs allow employers to facilitate a sense of ownership among their employees as well as create the proverbial ‘golden handcuffs.’ Granting company stock ties an important component of compensation to the company’s success, and both the company as well as employees may receive tax advantages.
As an employee’s stock awards continue to accumulate – all while the stock price is hopefully appreciating - they may wind up overly invested in their company. This may not seem like a problem at first glance. In fact, unless you are a founder or very early employee, concentration is rarely a problem at the onset.
Additionally, you likely have some amount of faith in your employer. It may feel like having a sizable amount of stock in your company is the equivalent of tying yourself to a rocket ship – nowhere to go but up. Unfortunately, investments in your company can very easily go in either direction. With this in mind, there are several very real risks to having an overconcentrated position.
What Are the Risks?
We all know it’s unwise to put all of your eggs in one basket. At the time of writing (March 2022), the NASDAQ has seen a 20% downturn from its all-time highs. This may seem like all the more reason for someone to stick with what they know and keep their portfolio concentrated in employer stock.
After all, they trust their employer! They know how hard the employees work, themselves included, and they trust their leadership team. In some cases, employees may even know what the plans are in the next several years to grow the company. They’re lured into a sense of security that their company’s stock will outperform a more diversified portfolio.
However, the wild swings of individual stocks can be jaw dropping to say the least. And the wild ride is not limited to esoteric stocks few have heard of; companies that most of us recognize and generally know as “successful” organizations have experienced downturns of 50% to 80% in the past. Even tech giants, such as the so-called FAANGs, are not immune from astonishing losses. Facebook (Meta Platforms, Inc.) and Netflix, Inc. dropped by 26% and 22%, respectively, on a single trading day earlier this year.
Downturns can happen to any company at any time and are often outside of the company’s control. If you’re heavily concentrated in company stock and your company experiences a major downturn, you could potentially lose a staggering amount of your net worth in one fell swoop. Further, employees with overconcentrated company stock may experience a double-whammy: precipitous net worth decline while also experiencing a layoff. In other words: your job and your savings could be in jeopardy.
How Can You Diversify Your Portfolio?
It’s understandable to have a fear of missing out when it comes to your company stock. What if the value of your company’s stock skyrockets in the six months immediately after you sell? How will you comfortably live with your decision to diversify your portfolio if you ‘miss out’ on returns? The truth is that timing the market is impossible. Those who try fail a large percent of the time. Instead, focusing on a diversified portfolio that’s tied to your personal goals is key.
If you know that you are overconcentrated in company stock, there are several steps you can take to achieve balance in your portfolio:
Understand where the concentration is coming from. Do you have RSUs, vested options, or ESPP shares? Will you continue to receive additional grants or have scheduled purchases in the future? If this is the case, your concentrated position will only be exacerbated over time. As your stock accumulates, you’ll become increasingly concentrated and increasingly at risk. Creating a roadmap of where your concentration is headed over the coming months and years is an essential first step.
Know the guidelines for selling your company stock. If you’ve reached a certain level within your company or are privy to material non-public information, you’re likely subject to specific rules surrounding when and how you may buy and sell company stock. Vesting schedules will naturally constrain when you can sell your shares. Further, some employers even have limits in place for how much company stock executives must maintain in their portfolios while they’re employed with the company. It can be helpful to write down all of the limitations placed on selling your stock so that you are able to see the big picture when developing a plan to diversify your portfolio.
Create a plan to diversify. Once you know when you can sell and what the process looks like, you are able to make informed decisions about the next steps. For example, you may decide that every time your RSUs vest, you’re going to sell them, withhold the taxes you’ll owe, and reinvest those funds without the risk that comes with owning a single company. Alternatively, you may decide to limit company stock exposure to a specific target percentage of your net worth or portfolio. As a final illustration, one of the best approaches is to 1) quantify how much your goals will cost – such as becoming debt-free, funding your child’s college education, or making major home improvements - and 2) identify how much company stock must be sold to make that goal a reality.
Even if an employee inherently understands that diversifying their portfolio to avoid an overconcentration in company stock is a savvy financial move, it’s often something that folks put off. Why? Because they are understandably loyal to their employer and are worried that if they sell too soon, they’ll miss out on a large gain. If this is something you’re facing, it can be helpful to look at your company stock in relation to your personal financial and lifestyle goals. Using our example of Netflix above, imagine that you are a Netflix employee watching the stock price drop by 20% in a single day. To illustrate, for an employee with 50% of their net worth in Netflix stock, their net worth would have shrunk by 10% that day. Ouch!
If you are a Netflix employee and your net worth suddenly loses 10% of its value, you could be facing significant setbacks on the path and timing toward your goals. You may suddenly find that using funds saved for big picture objectives and purchases in the near term becomes impossible, and this level of volatility could have far-reaching implications.
Don’t Go It Alone
Equity compensation is one of the most complex elements of financial planning, and it’s easy to make a mistake when navigating the how, when, and why of selling your company stock. Working with a fee-only CFP® with experience in company stock can help you create a strategy for your equity compensation and the rest of your portfolio. A guide in making these complicated decisions can help bring you peace of mind and a sense of confidence knowing you’re making decisions that serve your goals and values.