I’m fortunate to work for an employer that offers stock units to its employees. The number of units you could receive varies based on your job level and performance. Then, each year, a portion of your total allotment vests.
While this is something all employees at my company have in common, when the stock has performed poorly, it’s a non-topic.
Fortunately, like many stocks of late, the stock has performed well. And when it does, the following topics always re-surface:
“The stock is looking good, are you thinking of selling?”
“Are you still holding all of your stock?”
“At what point are you going to sell your stock?
“The stock is looking good, time to take some profits!”
“I just sold my stock. I’m rich b#%#@!!!!”
Why does company stock become such a hot topic in good times? It’s all about the price. And when prices reach heights that have not been seen recently, a few different mentalities kick in:
1. The Fearful Herd Mentality: almost nobody is investing outside of a 401K. And most 401K’s have a limited number of mutual/index fund investments. So nobody owns individual stocks! Once handed to them them, people have no clue what to do with them. And like typical beginner investors, everyone wants to time the market just right. There is an urgency to take action, for fear of losing money. So… we jump in to herd mentality.
“Everyone is selling? I should sell too!“, “Nobody is selling? Well, I’ll just hold for now.”
2. Capture and Spend Mentality: spend what you earn mentality starts creeping in. Many spend almost every dollar they earn, and when they see a large chunk of money sitting there, just waiting to be spent, they get an itchy trigger finger. Nowhere is this more true than when the gift of stock is bestowed upon us. If regular paycheck earnings are to be fully spent, then certainly unaccounted for stock earnings should be too.
“The price is looking good, so it’s time to fill my bank account so that I can buy all of that stuff I need!”
Does either mentality sound familiar?
Unfortunately, both mentalities are detrimental to wealth building. You shouldn’t do what everyone else is doing (witness the tens of millions who sold on the way to the bottom of the recession and missed out on the rebound). And spending everything you earn will mean that you will work until the day you die and probably encounter a few debt inducing emergencies along the way.
Here’s a little secret… when it comes to selling company stock, you’d be better off not even looking at the price at all.
When Should you Sell Company Stock?
Trying to time the market to sell all of your company stock at its perceived peak will deliver mixed results, at best.
But what other rules or strategies exist? I haven’t heard any good ones, so I’ll offer up a suggestion:
When company stock surpasses 5% of your total invested assets, it’s probably time to consider selling and re-investing more diversely.
Of course, first make sure you have accounted for capital gains taxes on employee stock sales.
Diversification within your investment portfolio is key and something you CAN control. Stock price is completely out of your control and can leave you open to serious risk.
Consider that diversified mutual funds are required, by the SEC, to not buy in to positions of any one investment that exceed 5% of the net asset value of the fund. Actually, there are three rules for diversified status:
75% or more of its assets are invested in securities
No more than 5% of its assets are invested in any one security
Contains no more than 10% of the outstanding shares for any one security
If you want your personal portfolio to remain diversified, you should think similarly. Keep your assets invested and not too much in one type of investment.
When you sell company stock, what you do with the proceeds from there is entirely up to you, but since it is “bonus cash”, it would be wise to then immediately re-invest it in something more diversified like an index fund or ETF versus letting inflation eat away at it while it sits in a bank account.
Lets frame this up a different way…
A family member you are visiting, on their deathbed, whispers to you, “I have accumulated a lot of wealth over the years through investing and want to give you $1,000,000 tomorrow, under only one condition: you invest 100% of it immediately and keep it fully invested in the market for at least the next 25 years.”
You agree (of course), and suddenly there are tens of thousands of wonderful stocks, index funds, ETF’s, bonds, etc. available to choose from. You’d want to diversify, spread out your risk a bit, right?
Would you then go out and put 100%, 50%, 25%, or even 10% of these investments in to your company stock? No? Then why is 10%, 25%, 50% or even 100% (yes, I have seen this) of your invested assets currently tied up in company stock? Stock is stock – whether you bought it or it was given to you by an employer should not influence whether you keep it.
Also, consider that (for most) 100% of current income will come from paychecks from your employer. Continued paychecks from your employer are dependent on your company’s success. And your financial success is dependent on continuing to receive those paychecks. In other words, your financial success is already significantly tied to your employer’s continued success. And your company’s stock price is also tied to your company’s continued success. What should happen if your company is no longer successful?
If you don’t think there is risk in this, revisit the Enron story. Half of their employees 401K values were in company stock, the company goes bankrupt, all employees lose their jobs, and then they lose their retirement savings.
So why do we often have such a disproportionate amount of our investments in company stock? I think there are a few reasons:
- we don’t know any better and the easy thing to do is let it sit there
- our company is so great that we are sure it will outperform the average and thus, it’s OK to be over-allocated to it
- we look at employee stock differently, since it was given to us versus if we had gone out and selected it on our own
None are legit.
Diversify. Diversify. Diversify. If for no other reason than peace of mind.
Company Stock Allocation Discussion:
- Do you receive company stock?
- What percentage of your total investments is allocated to company stock?
- What rule, if any, have you used to determine when you should sell stock?
Like many fortune 500 companies I have a pretty generous purchase price discount on my company stock, so the temptation is to over allocate. To take some of the emotion out, I set my allocation based on Morningstar’s 5-star rating system. So when they believe the stock is high undervalued (5 star rating) I invest 5% of my salary, when they believe the stock is highly overpriced (1-star rating) I invest 1% of my salary, etc. This isn’t a perfect system and I’m still slightly over allocated in my company (15% at the current moment), but I’m happy to carry a little extra risk due to the large discount. I also own no company stock in my 401K and Roth IRA which both contain straight forward index funds.
My company has two different programs:
1. A 401k stock gift at 1% of my salary every paycheck. This is immediately sold and moved to other funds.
2. A discounted purchase price. For this, I immediately sell to amount that I have put into the purchase (e.g. I pay $10k for $14k, I have $4k left as “frosting” that then goes with the market). By selling it as soon as I get it, There are little to no capital gains (sometimes small losses; I’ve luckily never seen a crash in those couple days). The “discount” amount is added to my income as straight pay and taxed this way, so selling later wouldn’t help it.
I am an employee owner in an ESOP. We get a bonus of 10-15% of our salary put into our employee stock ownership plan. I started working when I was 22 and now I’m 26. I invested in my 401k every year (I invested 20%, 15%, 10%, 10%, 5% of my salary each year respectively). The last 2 years I put all my 401k investments into a roth 401k, which is when my company began to offer one. The reason I’m investing 5% is because I started attacking my debt last year and decided my financial priority is to be debt free before I invest hard again. I have 30k in my 401k plan and 70k in my ESOP plan. The problem with the ESOP is that I cannot take anything out until I’m 50 (or 55), which is when I can roll 50% over to my 401k. At that point I can continue rolling over 25% each year. I feel like I’m stuck in the plan. I am projected to have millions of dollars in the ESOP by the time I’m 55 which will be a large portion of my retirement savings. Is there any thing I can do? I know there is a large trust that the company funds every year to be able to pay off retirees that the company can’t touch, but it still doesn’t take away much risk.
Basically you have your living costs and your retirement savings based upon your pay. If there was no stock as a bonus you know what your financial situation would look like. Now take the stock you have in the company plan and consider most of that outside of your budget. You probably had to pay tax on the stock you received, so the amount of the tax is the amount from your pay that needs to be considered when you look at how much the stock affects your financial status. All the rest is potentially gravy.
I’m all for diversification, but employee-ownership has its privileges, as well. I keep about 15% of my investments in my employer’s stock.
One comment here – there isn’t necessarily anything wrong with going long on your employers stock if you have other resources which allow you to hedge your risks.
Also, you should probably note the many value investor like Warren Buffet don’t necessarily diversify – they make their money from highly focused investing in specific businesses.