A Financial Guide To Owning Your Company’s StockSubmitted by Castlebar Asset Management on March 5th, 2015
Your company’s stock just hit a 52 week high, your 401k has reached a level worth paying attention to and your brokerage statements show your accounts keep growing! Financially things are going pretty well. Although one thing is kind of bugging you. You notice that your company’s stock is now a large percentage of your net worth. It has you thinking what is the right amount I should hold in my company’s stock?
Why own stock in your company?
Owning your company’s stock can be very rewarding both financial and professionally. It allows you to feel more like a business owner than just an employee. The long hours that you put in will have more meaning if you own a piece of the business. If you are positive on the future and what you are working for at the company it can be lucrative financially as well. If your company performs well you’ll benefit from an appreciating stock price and likely an increase in your income.
What could go wrong?
Having a sizable percent of your net worth in your company stock does have some consequences you need to consider. You are reliant on your company for your income, healthcare and other benefits. Having a large percentage of your net worth invested in your company stock leaves you vulnerable on a few fronts. If the company experiences a rough patch there is a possibility of staff reductions. The company’s stock is likely to see declines if they are going through a rough patch. You could suffer a compounding loss by being laid off and seeing your net worth hit at the same time.
Loyalty to your employer can sometimes leave you with tunnel vision. Management is usually honest but there have been some well documented cases where management misled employees about the prospects of the business. You may to be too focused on your job to notice that the business could be in trouble. This was the case seen in the 2000’s with Enron and WorldCom.
How much stock should I own?
The number that is often sited is you should actively reduce your holdings once you exceed 10% of your assets. This advice will cover most people but what is right for you is really specific to your goals, your risk tolerance and the direction of your company. The time to your largest financial goal (usually retirement) is going to play a key factor in determining how much of a concentration your company’s stock can be in your portfolio. If you are closer to retirement (less than 10 years) it is wise to decrease your holding below 10%. If you are early in your career, fewer than 10 years in, and have a long time to retirement (25 years or longer) than your ability to hold a more concentrated position is going to be higher.
The other criteria to consider is the prospects of your company. You’ll need to put your analyst hat on for a minute and be objective. This may be hard because chances are you are biased about your employer and its future prospects. If your company is well positioned in a stable industry you’ll be able to hold a larger percentage. If your company is in a very competitive industry you might be more conservative in your allocation. Another factor to consider is how volatile the share price is relative to other companies. A good measure to use is beta. This can be found on Yahoo! Finance or other financial websites. If your stock is greater than 1 it is more volatile than the market. If it is less than one it is considered less volatile. Combine both your forward looking thoughts of the company and past volatility and you’ll have good picture of if your business is conservative or risky.
The chart below shows some suggestions on much you can hold based on your goals and position of your company and a guide for your holding.
How did you end up with a stock position this large?
Accumulating a large position in your company stock usually happens over a long period of time so the issue of having too much stock does not occur overnight. You usually acquire stock through four different ways.
Employee Stock Purchase Plan (ESPP): This is a great way to invest in your company’s stock because these plans have several positive features. Typically you can buy the stock at a discount to the current price. Your company deducts the amount from each paycheck. This is another form of paying yourself first. You don’t pay any commissions to buy shares and you are dollar cost averaging your way into the stock. This is a fine way to accumulate stock but I usually recommend clients only allocate a small percentage or their paycheck to ESPPs. It is usually a better strategy to focus on maxing out your 401k contribution first. You are capped at contributing either 15% of your salary or $25,000 to an ESPP.
Restricted Stock Units or Stock Options: Receiving compensation outside of just a salary is normal for employees who are rising up the ranks at a company. Many companies will pay bonuses out in restricted stock units (RSU) or in stock options. These securities can be complicated to figure out but can easily start to increase your firms weighting in your portfolios particularly if the stock is rising in value. It is best seek the help of a financial advisor or financial planner to determine your overall exposure.
Employer Match in 401k: Some company’s use their stock for the employer matching contribution to 401k plans. This is far less common today than in years passed. If you have not been diligent about reducing your employer’s stock in your 401k in can start to creep up overtime.
Bought in your brokerage or retirement accounts: You purchased stock in your online, brokerage or IRA accounts on your own.
Getting things back into shape.
The first thing to do is come up with a plan. I would suggest you meet with a financial advisor, planner or accountant before you take any actions because of the possible tax implications. Don’t sell anything tomorrow to get things into your correct weighting. You did not get here overnight and you don’t need to correct things overnight.
In most cases you simply have to sell some of your stock in a manner that makes sense from a tax perspective (spreading it over a few years). If you bought your shares via an ESPP there are specific tax rules you’ll need to keep in mind.
Don’t try to time the market: You should set up a schedule to sell the stock on a quarterly basis or some frequency that makes sense. You company may have windows which you can sell certain shares. Do not try to time the market. It usually does not end well.
Change how you acquire stock: If you are buying stock through an ESPP unit should either reduce your purchase levels or have an active plan to sell shares once they hit long term gains.
Option strategy: I would strongly recommend you don’t take this step on your own. If you have a substantial position between stock, RSU or options you might consider using an option strategy called a collar. This will protect you from a draw down in your stock position. You buy a combination of a put option while selling a call option. There are other option strategies that could work as well. Please seek professional help before you head down this road.
This guide should give you a great starting place. If you have any questions or would like to meet for a free consultation about your specific situation please feel free to email me, call me at 913-660-0708 or fill out our contact form.
Andrew Comstock, CFA
Disclaimer: The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.