It’s easy to get excited about owning company stock. Owning stock in our employer makes us feel like a team player and more deeply engages us with the company.
However, at the end of the day, we often own company stock in the hopes of making money. If the company does well, then the value of your stock will grow, and you will benefit from that growth.
While owning company stock can be a good thing, it’s my job to discuss the other side of the coin – owning too much company stock. Owning too much company stock can leave you exposed to more investment risk than you may want or intend to take.
So, how much company stock is the right amount? Well, that depends on whom you ask.
The general consensus suggests that a diversified portfolio should have no more than a 10%-20% position in any one company’s stock. Simply stated, if you have more than this, you may have too much risk in your portfolio. Too much stock in a single company may lead to anti-diversification.
Personally, I tend to suggest the lower end of the rule of thumb for clients – 10%. That seems to be a good balance of diversification and participation in company stock. As always, an exact answer depends on a number of personal factors.
Why Shouldn’t I Have More Than 10%?
That’s easy. There may be too much risk.
Having a large position in one stock may immediately increase your risk level.
Having a large position in one company stock may seem like a great idea when the markets are up, but as we know, trees don’t grow to the sky. What goes up must come down. Pick your favorite cliché – there are plenty of them.
Many, if not all, stocks will experience periods of fluctuation. During these times of fluctuation, a person with a highly concentrated stock position may see their account balance go up or down significantly.
Even worse, what if your company goes off the deep end and goes bankrupt (remember Enron)? What if you have all your investments tied up in one company and the stock value plummets to zero?
Now you may have lost all your investments, potentially your job, your healthcare, and your income. Think it can’t happen to you? It’s happened before. This is why I encourage clients not to over-invest in their own company’s stock, or any other company’s stock.
By contrast, you may want to consider a mutual fund or an ETF, which are often automatically diversified. They often invest in dozens or even hundreds of stocks at the click of a button.
But That Won’t Happen to My Company
Emotions can have a big impact on decision-making. Specifically, emotions can play a major role in how you buy and sell your investments. Employees who own company stock may often be guilty of buying and selling company stock on emotion, rather than rationale. Reason being, you potentially feel very comfortable with your company, with your employees, with your paycheck, and with your product or service.
You may feel so comfortable that you may be providing yourself with a false sense of security. You may think that the stock is special, such as a gift that can’t be sold. Or maybe it feels like you would be cheating on your company if you sold.
Unfortunately, investing on a feeling, a comfort level, or a gut emotion is rarely, if ever, a good reason to make an investment decision.
Other times, I see clients who don’t want to sell their employer stock for tax reasons (the tail wagging the dog). The unfortunate circumstance of making a lot of money could be paying a lot of taxes. Sometimes, it’s the simple opinion that “this could never happen to me.”
Finally, I see clients who believe that since the stock has performed well historically, it will continue to perform well. Often, this past performance isn’t the result of detailed analysis. It’s the result of the account value being higher (maybe it would have performed better elsewhere?). Regardless, it’s important to remember that past performance is not predictive of future performance.
But I Can’t Help It – They Are Giving Me Stock Options
As you move into your career and scale the corporate ladder, it’s not uncommon to receive stock options. As you receive these stock options, it’s possible that a significant percentage of your net worth may be tied up in company stock.
Therein lies the problem. You want to be prudent and maintain a reasonable allocation to your company stock. However, you may not be able to sell the company stock options that you own. As such, a growing percentage of your net worth is in company stock, via incentive stock options, non-qualified stock options, and restricted stock.
When you find yourself in this conundrum, you may want to consider several options that may help increase your diversification while you wait for your options to vest.
- Stop buying company shares elsewhere – It’s possible that you’re buying shares through an employee stock purchase plan, an investment account, or via your 401(k) plan. If your total allocation exceeds a “normal” range, you may want to stop buying more (even if you receive a discount).
- Sell the company stock you own – In addition to not buying more stock, you may want to consider liquidating the company stock you own. When your total net worth from your options exceeds a comfortable ratio, you may want to consider reallocating the assets you can control.
- Develop and stick to a diversification strategy – Often, I see clients who treat stock options as compensation. As soon as they can access their shares, liquidate them, and diversify them elsewhere, they do! They are not interested in wishfully hoping the stock will double or triple in value. What they are interested in is prudent investment allocation and diversification. A bird in the hand is better than two in the bush, as they say.
Company Stock and Retirement Planning
At a certain point, many feel that when you have a certain amount of money in the bank, enough is enough.
Enough is enough when you are able to meet your retirement goals and expenses and not run out of money. For many, this is the singular goal. Can I retire and not run out of money?
I regularly meet with clients who have “enough.” However, a large portion of their net worth continues to be allocated to company stock.
They fear that by selling now, they will be missing out on the upside of the stock. They fear that they are going to be the one standing on the sidelines when the rest of their co-workers get rich.
At the end of it all, what will hurt more is not being able to retire because the market may have dropped and you no longer have “enough.”
Employers offer many ways to own company stock. You can own stock through an employee stock purchase plan, through stock options (restricted stock, phantom stock, incentive stock, etc.), through a 401(k) plan, and through outright purchase in a brokerage account.
The ease with which you can access company stock makes it easy to buy and buy and buy. Ultimately, this may lead to owning more than 10-20% in company stock.
To make sure that you’re in line with your personal goals and risk tolerance, it’s important to review your existing asset allocation and determine how much of your money is tied up in company stock. You may want to also evaluate how much stock you expect to receive in the future as part of your compensation package.
Next, you should evaluate your risk tolerance, your time horizon, and your goals to determine whether your allocation is appropriate.
Then, you should understand what the tax implications and opportunities are for every type of stock you own.
Finally, I would recommend that you develop a plan to maintain an appropriate level of company stock that meets the dual mandate of helping to achieve your goals and staying within a reasonable level of risk.
None of the information in this document should be considered as tax advice. You should consult your tax advisor for information concerning your individual situation.
Neither diversification nor asset allocation guarantees a profit or protects against a loss.
An exchange-traded fund (ETF) is a security that tracks an index, a commodity or a basket of assets like an index fund, but trades like a stock on an exchange. Investors must buy or sell ETF shares in the secondary market with the assistance of a stockbroker. In doing so, the investor will incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.
There is no assurance that a mutual fund will achieve its investment objective. The fund is subject to market risk, which is the possibility that the market values of securities owned by the fund will decline, and, therefore, the value of the fund shares may be less than what you paid for them. Accordingly, you can lose money investing a fund. Please obtain a prospectus for complete information including charges and expenses. Read it carefully before you invest or send money.