Incorporating Company Stock into Your Overall Financial Strategy

| December 04, 2018
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Many publicly traded companies offer employee benefits programs that provide their workers and executives with exposure to company stock through various channels, such as bonuses tied to performance, discounted employee stock purchase plans, restricted or unrestricted stock grants as part of a compensation package, deferred compensation, stock options, or as one of the investment choices in their 401(k) plan.

This generous yet strategic financial incentive encourages employees to become more vested in the company’s success. After all, if you’re a stockholder, you’re an owner of the company, and the expectation is that you’ll work harder and smarter because these efforts could pay off, literally, down the line.

As a financial advisor, I often find that people mentally compartmentalize their assets, frequently treating company stock exposure as “money the company gave me” or “not actually my money.” While company stock is a perk — and a potentially valuable one – it’s important that you view it as any other investment in your portfolio and treat it similarly.

You are part of an “in crowd,” but you still need to think strategically
Often employee stockholders who work at their company for many years tend to stop looking at that company stock objectively. They look at it emotionally, which makes it difficult to recognize bias. In behavioral investing, this is called familiarity bias and it reflects an investor’s tendency to invest in the known. Investors may perceive investments they are knowledgeable about as either less risky or more rewarding, and oftentimes both.

If your initial $300,000 in company stock is now worth $900,000 – congratulations, you’re moving in tandem with the market, which has tripled in value over the last 10 years. But with all your eggs in one basket, you took on a lot of concentrated risk for the same return you’d receive if you had been diversified.

Ask yourself: If you just inherited $3 million in cash, would you invest $2 million of it in a single stock? Most people consider this a ridiculous question. “Of course not, you need to diversify,” they’d say. And yet we have clients come to us with portfolios that are two-thirds or more company stock.

Inertia is a powerful force. You may say, “This stock has been good to me.” But you need to ask yourself, “What’s more important: being a team player or being your family’s financial security?” History has witnessed multiple stock performance downfalls that should serve as valuable lessons to current company stock investors: Don’t go down with the ship. Ask the employees of a well-known, global telecommunications company who rode the stock from $70 down to less than a dollar when the tech bubble burst in 2000 if they would do things differently if given a second chance.

It’s important to know when to stay and when to get out
Given that your company stock should be just one component of your portfolio, it should be included as part of your overall financial strategy as well. In our experience, many clients have not aligned their company stock with their financial goals and often choose the wrong way to expose themselves based on their risk profile, financial goals, time horizon, and tax situation.

  • If your goal is to hold the stock long-term and include it as part of your estate, there are different ways and places to hold that stock to yield a better after-tax return.
  • If you know you will need to cash out some stock in a shorter timeframe, i.e., in five years to pay for your children’s college education, there are different accounts you can use to diversify your exposure and your risk in case a sudden shift in stock value leaves you with less than you need.

When winning sometimes doesn’t feel like winning, and losing feels awful
Believe it or not, even if your company stock does well and you sell it for a profit, you can still lose out. That’s because you don’t get to keep all the gains from when you bought to when you sold; Uncle Sam wants his piece of the pie.

Which is why it’s so important to have a clear understanding of the differences between the various
exposures to company stock and how each type gets taxed, at what rates, and when. For example, there are two different types of stock options that may seem similar upon first glance, but they actually can have a dramatically different impact on what you net after taxes. Another example is investing your company stock in a 401(k) or through deferred compensation. How and where you invest is a critical determinant of what you get to keep.

But sometimes you don’t get to keep of any of it, and you must be prepared for that situation as well. Should the company stock underperform, you need to ensure it won’t derail any or all of your other plans.

Turn to a professional for a better shot at winning
If you are or plan to become a company stock owner, talk to your financial advisor. You need a game plan if the stock continues to do well. More importantly, you need a game plan if the stock doesn’t do well and you will need to identify what impact, if any, a substantial drop in the company stock value will have on your financial goals and/or retirement.

It’s important to have these conversations now while you can still protect yourself and your tax exposure. Owning company stock is an excellent tool in your investment toolbox. But if is not properly integrated into your overall strategy, with risk/reward and tax consequences taken into consideration, it can be more bust than boom.

Diversification does not guarantee profit nor is it guaranteed to protect assets.

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