Strategies For Your ESPPSubmitted by Castlebar Asset Management on November 16th, 2016
Employee stock purchase plans (ESPP) can be an overlooked benefit from your employer and you could be leaving a thousand of dollars each year on the table by not participating! ESPPs can be an important helper in building wealth and reaching your goals. They are not the type of account that can be left alone for years, they need some attention along the way.
A typical situation I see with an ESPP is something like this. An employee decides to contribute a few percent of their income each year into their ESPP. They work at the company for a couple of years and don’t think twice about this account. They get promoted, their company’s stock is moving higher and they earn more money. Everything is looking great. They keep an eye on their ESPP balance and it is headed higher but they really don’t know what to do, so they do nothing. During this time their company stock is becoming a larger and larger part of their net worth through their ESPP, as well as, their income (human capital). One of two things happens; the company hits a rough patch and lay offs happen or there is down period for stocks and their concentrated position holding is now a problem. What was once a great thing is now a source of frustrating and angst. When prospects come to us we always sense their frustration on not knowing what to do or what they should have done. Having a plan would have solved some of their frustrations.
ESPPs can be awesome, but they need to be tended to, otherwise they can become a headache in your financial life. Here are two strategies we recommend for clients to look at their ESPP’s.
The Discount Hound
ESPP typically allow you to buy shares at a discount of 15%. This gives you a great head start on gains because you are buying shares below current market value. There is a strategy for those who don’t want to own your company shares for a long period of time, but rather take advantage of this discount and diversify into other investments. We call this strategy our discount hound approach. You set a plan to sell your shares in your ESPP each year. If there are losses, you can sell prior to one year mark and if there are gains you sell just after a holding the shares for a year to optimize your taxes This strategy does require you to look at your account either annually or quarterly.
It is a good strategy for capturing your discount but does require a little work on your part. It is beneficial if you don’t want to have a concentrated position in your employer’s stock. You will have to pay some taxes along the way but it minimizes risks and allows you to reinvest the proceeds elsewhere. Some clients use the proceeds from their ESPP to help out with 529 accounts, beef up their emergency fund or invest for retirement. Some people feel bad selling their company shares but this is a disciplined approach to take advantage of an employee benefit. You are not a disloyal employee for selling your stock!
The Cautious Accumulator
The Cautious Accumulator is a strategy to follow if you are optimistic about your company’s future and have the financial flexibility to own a little more of a concentrated position in your employer’s stock. You let your ESPP build up over time but still trim your holding periodical based on some simple rules. The most important rule is you never let your company stock become too large of a percent of your net worth. You set a limit of your net worth which could be 5% or a number closer to 20%. Whatever the right number is something specific to your situation. You can meet with a financial planner or invest advisor to figure out what the right amount to hold for your situation.
This strategy will allow you to benefit from the discount and compounding of gains over time. Once again, you can’t set and forget, it does require some level of activity. It is beneficial for those who want to feel like they own a meaningful piece without it having significant consequences if something negative impacts your company or its stock. You should factor in employee stock options, RSUs or a company match in your 401k to your over all net worth and company stock exposure analysis.
Some simple rules or guidelines will help you stay focused. Set a reminder to look at your ESPP either quarterly or annually. Plan on acting when this reminder pops up. Don’t hold onto your shares because you feel that your stock will go up just a little bit more. It is better to sell to early than miss out if the stock heads lower.
Understand the important valuation numbers for your company and how it compares to others in your industry. Know how your company is valued relative to itself historically. If your stock is more expensive based on your valuation analysis, sell some of your stock in your ESPP. Avoid selling your company stock near its 52 week low. If you are concerned about the company’s future or you have not sold shares in the last 12 months sell some shares no matter the price.
ESPPs can be a helpful tool to meet your financial goals if managed correctly. These are two strategies among many that we can use to manage an ESPP as part of your overall financial plan. Having a plan when you contribute to an ESPP, don’t contribute blindly and hope. Having a plan will give you a better outcome in the long run.
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 personal financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results.