Buying company stock at a discounted price can be worthwhile—if you remember to diversify as soon as possible.
Beware of putting all your eggs in one basket. Owning company stock means that if your company does badly, you could lose both your income source and your investment value at the same time.
If you are one of the millions of Americans working for a publicly traded company, at one time or another you have probably considered owning stock in the company where you work.
Sometimes an employer gives you stock, or stock options, as part of your compensation. Or maybe an employer provides an opportunity to buy company stock, sometimes at a discount. Whatever your situation, it is important to understand the risks and potential rewards of owning stock in your employer.
This piece will talk about whether you should buy and hold company stock. Betterment’s typical advice is that diversification is king, and you should avoid a concentrated position in one holding. However, buying a company stock at a discounted price can also be worthwhile—if you remember to diversify as soon as possible.
Should you buy company stock?
Owning company stock is different from owning other investments for several reasons. While the stock value may increase over time, holding too much of your company’s stock can be a major risk for your personal finances.
The biggest risk is that, because your employer is your main source of income, owning company stock means that if your company does badly, you could lose both your income source and your investment value at the same time. While this is not common, it is not unheard of, either. Think of companies like Enron, Arthur Andersen, and Lehman Brothers, as examples.
As long as you minimize unnecessary company stock in your portfolio—or in your retirement accounts—holding company stock for a short period can be a good way to amplify your savings. For example, if your company allows you to buy stock at $0.75 while the market price is $1.50, you’re getting a 100% return immediately. In this form, company stock represents a way to increase your capital without saving as much. But, you need to balance that against restrictions on diversifying out of it.
The first place to look when considering buying company stock is your company’s benefits plan. Large employers sometimes offer an employee stock purchase plan (ESPP), where you can buy stock at a discount. In these plans, you typically select a desired percentage of your regular pay to purchase company stock. On a monthly basis, those funds are used to purchase shares at a discount from the current market price, generally around 15%. If you can get stock at a discount and sell without restrictions, you are instantly earning a profit on your share purchases.
When to Use Caution
Before buying through an ESPP, be sure you are not held to any vesting rules or holding periods on the stock that you purchase. Some ESPPs require you to hold the stock for a certain length of time before you are permitted to sell. During that time, you are locking your money in one specific stock, which can be particularly risky for you, the employee, and no one can guess what your stock value will do in the meantime.
You should also consider your status at the company. If you hold an upper management position, work in the finance group, or are in possession of any material, non-public information, selling your company stock may conflict with insider trading laws. When in doubt, contact your company’s human resources or legal department before buying or selling.
You will also want to consider other equity compensation your company offers when buying company stock. If a large portion of your compensation consists of company stock or stock options, you may consider passing on a stock purchase plan to avoid holding too much of your personal net worth in your company’s stock.
Understand Your Vesting Schedule
Vesting schedules can add an extra complication to your stock compensation and ability to participate in an ESPP, so it is important to understand how they work before you buy additional company stock.
Vesting is a common tactic used by companies to encourage employees to stay on board for a longer period of time before leaving for another employer. Vesting is typically applied to stock options and 401(k) plans, but it can also be applied to an ESPP.
With a vesting schedule, you are granted a certain portion of your stock, stock options, or 401(k) match over a period of time. For example, if you are granted stock with a three-year vesting period, you are given access to 33% of your stock each year for three years. With a four-year vesting schedule, you will receive 25% of your stock each year for four years.
Companies have complete control over the vesting schedules and can grant the entire value at the end of the vesting period, proportionally throughout, or on any other schedule outlined in your company’s policies.
Exceptions for a Controlling Stake
In most cases, putting all of your eggs in one basket is not the best investment strategy. In the few cases where it makes sense, accommodating a large amount of company stock may be an important part of your asset planning.
If you work in an executive management position, your compensation is most likely heavily concentrated in company stock. This is an incentive to pay managers more if the company performs well. And, as an insider, your stock ownership is publicly reported by law, so Wall Street analysts and investors will be watching every purchase and sale you make. If you build up enough stock in a company, your ownership will give you a significant voice in company operations.
If you are a major owner or company founder, your ownership will likely be much higher. In those situations, it may make sense to maintain or build a larger ownership stake to give yourself a controlling stake in major decisions, if you think that your votes will improve the company’s prospects.
What should an employee do?
Assuming you are not in executive management, your best option is most likely a “buy and liquidate” strategy, if you can buy company stock at a discount and then sell right away. Of course, you should consult your investment adviser and tax professional to make sure this is the most suitable option for your specific situation.
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