Have you heard of the term "concentrated position?" It means that an investor has a large portion of their investment portfolio in a single stock. One of the most common reasons this happens with your company stock.
Maybe your company just went public, and your stock options became real shares that trade in the market. Perhaps you've built up holdings through an Employee Stock Purchase Program (ESPP). Or maybe over time, value has accumulated through a combination of share-based compensation, and your company has done well.
Regardless, this presents a special planning challenge. There are significant tax and risk considerations in these situations that your planner can help you tackle.
How much can you afford to risk?
Holding any individual stock as a large percentage of your portfolio is risky. Even large and seemingly well-established companies can experience extreme volatility.
For example, using the S&P 500—an index made up of 500 of the largest US companies—79% have experienced a 50% drop or worse from their highs sometime in the last three years.
Moreover, one out of every 12 companies suffered an 80% drop or more. That's approximately the odds of rolling a 4 or a 10 with a pair of standard dice.
To put things into perspective, imagine every time you roll a 10, your wealth drops by 80%. That's how risky these single positions can be.
Clients often wind up with significant concentrated positions due to a recent initial public offering (IPO). If the company is small and cash-strapped (like a startup), it often uses more share-based compensation than its larger counterparts. In the event these companies make it to the public markets, long-time employees have the potential to realize something of a windfall.
While this is a delightful problem to have, holding a concentrated position in young companies is even riskier than the average individual stock.
For example, according to Bloomberg data, there were 190 IPOs on U.S. exchanges (not including SPACs, ETFs, and closed-end funds) in 2021. Of those, 26% (~49) have experienced an 80% decline.
Look at your whole picture
The risk of holding large amounts of stock in the company you work for goes beyond just the value of your shares. For example, you may have future equity-based compensation, such as options, that will increase exposure to your employer's share price.
Or you may participate in a bonus pool or a profit-sharing plan. It is generally true that when company profits are down, so is the share price. Therefore, it is likely that the bonus pool would also be leaner in those same periods.
Lastly, there is always the risk that a company goes out of business. During the Great Financial Crisis, many employees of long-successful firms like AIG, Lehman Brothers, Bear Stearns, and Wachovia went from being paper millionaires to unemployed in rapid succession.
Even if the risk feels low now, it is important to consider the possibility that both your personal wealth and your employment could be at risk simultaneously in a disaster scenario.
Diversification is ideal, but it's complicated
So the good news is that the stock in your company is worth a meaningful amount of money. The bad news is that retaining the stock comes with all the risks described above. There is an uncomfortably high risk of a disastrous outcome for your personal net worth.
In a perfect world, we would recommend selling your company stock and reinvesting in a diversified portfolio of stocks and bonds. This allows you to capture the value gained in your company shares and avoid the risk of undue future volatility. But unfortunately, the reality is often more complicated, and each client's situation is a bit different.
One big consideration is taxes. Depending on how you acquired the shares, selling the stock may have a significant tax consequence. However, in most cases, we recommend selling most or all of your shares despite taxes, as the benefits of diversification outweigh the tax costs.
However, depending on your personal circumstances, we may choose to manage the sales over a period of time to spread out your taxes. Your Facet planning team can work with you to determine the most tax-friendly strategy for diversifying.
There may be other considerations that are relevant to your decision beyond just taxes as well. For example, you may be subject to lock-ups or reporting requirements that make sales difficult. These are all factors that Facet can help you work through to ultimately get the right plan for you.
What if I really want to hold my company stock?
It is very common for people to feel an emotional attachment to their company stock. You may have worked there a long time or been with the company in its early stages. You may also genuinely believe in the company's future and expect the stock to rise significantly.
For these reasons and others, we do not always recommend clients sell all of their company shares. Instead, we work with you to determine an acceptable amount of risk. This might include your other financial resources and overall exposure to your company's stock.
If you decide to keep some of your company stock, Facet can help manage your other investments to maximize the diversification benefits of your stock holdings.
Knowing what to do with your employer’s stock can be tricky, but help is only a click away.
