Unlike most questions in financial planning where the answer is typically “it depends,” the answer in this case is decidedly yes; you can have too much employer stock — and many people do.
There are five common ways individuals can wind up in a concentrated stock position. Most commonly, employees don’t realize how much of their financial future is tied to their employer. The same principles of diversification and risk management that apply to asset allocation in an investment account apply to your entire financial picture.
So if everyone knows the old saying “don’t put all your eggs in one basket,” why do so many people do just that?
[See: 7 Stocks That Could Save Your Portfolio.]
Five ways you may be holding too much employer stock. Many employees in need of diversification from a concentrated stock position are surprised to learn how much of their financial life they have tied up in their employer. Exactly how much stock you’re holding can be difficult to assess as there are often multiple ways you own the stock. Here are common ways individuals hold too much employer stock:
— Compensation package is too heavily weighted in company stock options or awards.
— Company 401(k) plan match is in shares of the employer’s publicly traded stock instead of cash.
— Once stock options are exercised or awards are vested, individual does not have a plan to systematically liquidate the shares.
— Employee participates too heavily in an employee stock purchase plan.
— Individual purchases shares of their employer’s stock independently for their own personal accounts
If it were any other stock, would you hold this much of it? Being optimistic about the future of the company you work for is a good thing. Blindly betting on it is another. When it comes to owning equity in an employer, individuals sometimes ignore the risks or simply have no idea how concentrated they are.
The danger in holding a lot of your employer’s stock. Buying single stocks is itself a risky strategy as there is no diversification from risks specific to that company or industry. Regulation, technology, commodity prices, competitors, and even scandals can cause irreparable damage to the value of a firm and the stock may never recover.
Employees can get hurt by a lack of diversification at thriving companies also. When companies merge or get acquired, there are a number of things that could happen to your stock options or restricted stock units. Depending on how a deal is structured, shares may be diluted, or in an all-cash deal, such as when Microsoft Corp. (ticker: MSFT) purchased LinkedIn ( LNKD), Microsoft shareholders were not diluted but they had to bear the market risk of the transaction alone.
For employees with unvested options or awards, the outcome is even more uncertain as the merger and acquisition agreement could accelerate the vesting period or cancel them altogether. Until liquidated, there’s always a risk in relying on proceeds from equity compensation, whether vested or not.
Outside of the value of the employer stock itself, you already have “employment risk,” which is the fact that you’re already betting a lot on your company by working there. Unless you are independently wealthy, chances are you rely on your paycheck to cover your living expenses. You likely also have health insurance coverage with your employer, and may also have life insurance in addition to other fringe benefits. Businesses commonly cut back on benefits and staff when they need to tighten their belts. If you haven’t diversified, you may be stuck on a sinking ship and forced to sell at a loss.
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Diversify out of a concentrated stock position. In general, no more than 10 percent of your net worth should be in employer stock. That way, even if an Enron-like event were to occur, your losses are somewhat limited. In the five ways employees can hold too much stock, some of the causes are easier to combat than others.
If your compensation package is too heavily weighted in company stock options or awards you can try to renegotiate to receive more cash compensation. This is likely the most challenging of the list. If your employer doesn’t want to renegotiate and you feel as though you’re in a bad situation, consider finding a new job.
If your company retirement plan match is in shares of employer stock, read the plan documents. Most companies who match only in employer stock will allow you to sell the position and diversify immediately. There are still a small few who may still require that stock is held for a few years. Even though this is technically allowed, it may be worth filing a complaint with your HR department.
Develop a plan to systematically liquidate shares of employer stock once you are able. There are tax consequences to be aware of which can get complex depending on the type of stock options or equity awards granted, so work with your CPA and financial advisor on your strategy. Although you don’t necessarily have to sell all of your shares upon vesting, keep in mind the 10 percent rule.
Some employees who are already granted stock awards or options also elect to participate in an employee stock purchase plan. While an ESPP may allow you to purchase stock at a discount, it is easy to find yourself in a concentrated stock position when you already receive stock as part of your compensation package. If you do not currently have another form of equity based compensation, an ESPP may be a good option — just be sure to understand the terms of the plan, tax consequences, and recall the 10 percent rule.
Individuals who purchase shares of their employers stock on a public exchange have full control to diversify themselves out of a concentrated stock position. Depending on how concentrated you are, your liquidity needs, and future outlook of the business, you may be forced to sell some of your shares at a loss. Work with your CPA and financial advisor to develop a plan to sell the shares and potentially offset the tax liability on some of your other investment gains with these losses.
Consider donating highly appreciated securities to charity. Donating stock to charity can be a great way for some individuals to reduce their taxable income while accomplishing their charitable goals. When you give appreciated securities to a qualified charity, you can receive a charitable tax deduction for the fair market value of the stock on the day of donation without having to realize any capital gains.
Having enough faith in your employer to “put your money where your mouth is” and invest is a good thing. Just don’t forget that you’re already investing by working there.
[Read: How to Donate to Charity on Any Budget.]
When managed properly, equity compensation can provide employees with a unique opportunity to participate in, and profit from, the growth of the company. You may have no control over where your employer’s stock will ultimately go, but you can put limits on the extent to which it may affect you.
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Can You Have Too Much Employer Stock? originally appeared on usnews.com
