Should I Own Stock in the Company Where I Work?
Buying company stock at a discounted price can be worthwhile—if you remember to diversify as soon as possible. The answers to these four questions can help you make your decision.
Stock options provide an option, not an obligation, to purchase company stock.
Buying company stock at a discount can be beneficial if you understand and manage the risks.
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.
Whether you are an early employee at a new start-up, or a tenured manager at a large company, you may have been offered stock options as part of your compensation or bonus.
The world of equity compensation can be confusing. Dive into these four questions to help you better understand stock options and how they can be used to your advantage.
What are employer stock options?
Stock options simply give an employee the option to purchase shares of employer stock at a predetermined price.
You can think of stock options somewhat like a corporate discount for your local gym. Your company wouldn’t simply give you the gym membership, but rather the ability to join the gym at a lower price than the general public if you choose to sign up.
Stock options can get complicated, so before going any further, let’s review a short list of key terms pertaining to employer stock options that are important to understand.
Exercising your options means to employ your right to buy shares at the grant/exercise price.
The date you purchase the shares of company stock by exercising your options.
The date your employer offers you the options.
Grant Price (Also Exercise Or Strike Price)
The specific price you pay if you choose to buy the shares of company stock in the future.
After the grant date your employer will likely make you satisfy a waiting period known as the vesting period, before you own your options. If you leave the company, you will only be able to hold on to the options that have fully vested.
While the vesting date starts the clock on when you can exercise your options, incentive stock options (ISOs) do not last forever. These options expire 90 days after you leave a company, and 10 years from the grant date if you remain employed at the company.
The difference in the exercise/grant/strike price and the market value of the stock on the exercise date.
Types Of Stock You May Be Offered
Incentive Stock Options (ISOs)
These are statutory stock options that have more favorable tax treatment than nonstatutory options. Generally you do not have to add the options to your gross income at grant or exercise. You should be aware however that you may be subject to the Alternative Minimum Tax (AMT) in the year you exercise. When you sell shares that were acquired from exercising ISOs, your tax treatment will be determined depending on how long you held the shares.
Employer Stock Purchase Plan (ESPP)
A company-run program that gives employees the ability to purchase shares of company stock (typically through payroll deductions) at a discount up to 15% below the market value. Payroll deductions accrue over a specific offering period, and then the shares are purchased on behalf of the participating employees. ESPPs are a convenient way to own company stock without having to execute the transactions yourself. With ESPPs, you will not pay taxes on the discount received, until you sell the shares.
Nonstatutory Stock Options (NSO)
NSOs do not receive the same favorable tax treatment as incentive stock options. You will pay income taxes when you exercise NSOs. At exercise, the bargain element will be taxed as ordinary income. When you sell the shares acquired through exercising NSOs, you will pay short or long term capital gains taxes depending on how long you held the shares.
How do stock options work?
Every company operates differently, and can impose their own rules and restrictions, but below is a general timeline of how stock options work.
- Your company grants you stock options on the grant date.
- You remain employed throughout the vesting period.
- Once your options are vested, you can choose to exercise/ buy the shares of stock.
- After exercising, you own the shares. You can then choose to hold the stock, or sell it.
Should I purchase company stock and/or exercise my options?
Because stock values may increase or decrease over time, holding too much of any company’s stock can be a major risk for your personal finances.
At Betterment, we strongly believe that good diversification is a key ingredient in a smart investment strategy. Holding too much of any one company’s stock often creates a concentration of risk that you should avoid. When you hold too much of your own employer’s stock, this risk can be magnified. In most cases, your employer is your main source of income.
Owning company stock means that if your company does poorly, you could lose both your income source and your investment value simultaneously. While this is not common, it is not unheard of, either. Think of companies like Enron in 2001 and Lehman Brothers in 2008.
As long as you minimize the company stock exposure in your portfolio, 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/share while the market price is $1.50/share, you would have a 100% return on your investment from buying and then selling your shares immediately.
Is company stock a way you can increase your capital without saving as much?
You might be thinking: but I want to participate in the future growth of my company. What should I do?
Many people would normally be thrilled with a 100% return (from the previous example), but when it comes to employer stock, many investors ignore the risks and choose to hold on to their shares in hopes of participating in the future growth of the company.
While it might be wiser to sell and capture that gain, we get it: you believe in the success of your company and want to own a piece for yourself. In this case, we recommend that you limit the amount of company stock you hold to about 5%-10% of your portfolio value.
Generally, exercising company stock options can be a great way to boost your investment portfolio if you take a prudent “buy and liquidate” strategy. If you hold on to too much company stock, you run the risk of losing not only the value of the discount but the entire value of the stock.
As mentioned earlier, employer stock options are complicated, and details can vary by employer, so always be aware of any limitations, and/or restrictions you may be subject to before making the decision to exercise and/or sell. If you have any questions or concerns, consider checking in with your HR or legal departments.
As with all large financial decisions, you should consult your investment adviser and tax professional to determine the most suitable choices for your personal situation. Book a call with a CERTIFIED FINANCIAL PLANNER™ professional who can help you make the right decision when it comes to purchasing employer stock.
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