If you are on the receiving end of equity compensation in the form of employee stock options or restricted stock, it’s easy to get excited about the prospects of an increasing stock price and how that can positively impact your financial future.
Company stock can offer non-financial benefits as well, like making you feel invested in the company, like a team player, and that all your hard work is worth it.
Of course, there is a downside to receiving stock or stock options: while values can rise, share prices fall, too. If that happens, you may find yourself wishing that you had invested elsewhere.
Which leads us to the question: Is owning company stock worth it? And if it is, is there such a thing as too much company stock?
Understanding the Impact of Concentration Risk
Having a single stock represent a large portion of your overall investment portfolio usually presents you with more risk than investing in a more diversified basket of securities.
Specifically, you expose yourself to concentration risk when you do this. This is usually defined as having more than 10-15% of your portfolio invested in a single position.
One concern is that as your stock allocation increases as a percentage of the portfolio, its performance starts to drive your overall investment performance. While that can open the door for greater upside, you can’t have potential for big returns without the reality of facing big risks.
Should that single stock price fall, it could dramatically reduce your net worth to a point where you put your goals and future needs (like funding for retirement years) in jeopardy.
How Much Company Stock Should You Own?
Many individual stocks experience periods of volatility, and your own employer’s stock is no exception. During these periods, the unrealized value of a concentrated position can swing by huge amounts.
While that’s true of any concentrated position, you may be especially vulnerable when it comes to holding big amounts of company stock — because you’re not only invested in the company, but that business also pays your salary, provides your healthcare, and keeps you employed.
Therefore, sticking to the rule of keeping no more than 10-15% of your overall portfolio invested in a single stock may become even more critical of a benchmark to follow both to mitigate volatility, potential returns, and hazards to your overall financial life.
If your company stock plummeted in value and you were laid off, you could be left in a very bad position. If you maintain a reasonable exposure to your employer’s stock, on the other hand, a loss may still hurt… but it could be the difference between taking a bit of a blow and being financially devastated.
That’s a good reason to adhere to the 10-15% guideline. But even if you’re on board with this plan, actually executing can be difficult due to any number of reasons that prohibit you from selling your shares, like blackout periods or vesting schedules.
As such, you may be forced to own and control a growing percentage of your net worth that’s invested 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 how and when you can sell your shares and plan to do so accordingly.
Managing Your Exposure to Company Stock
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. To make sure that you keep your investment portfolio and exposure to any one position aligned with your personal goals and risk tolerance, it’s important to review your existing asset allocation on a periodic basis 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 so that you can proactively plan to manage those incoming shares.
Next, you should evaluate your risk tolerance, your time horizon, and your goals to determine whether your allocation is appropriate. You should also consider the tax implications and opportunities 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.
How Company Stock Fits into a Retirement Plan
Whether you have some or a lot in company stock, you may feel at some point that you have enough saved in personal assets and company stock to retire. For this purpose, “enough” is sufficient assets to meet all of your retirement goals and expenses and not run out of money. For many, this is a primary goal.
As you approach and near retirement, you should plan to re-evaluate how much you have in company stock, how that allocation impacts your risk profile, and what actions you may need to take to align the risks you’re taking with the reality of reaching the point at which you want to start withdrawing from your assets to provide a retirement income.
Keeping a large percentage of your net worth tied up in a single stock presents even more risk the closer you get to the date at which you want to use the money you have invested. If the stock price goes down, the value of your portfolio may also go down, leaving you in a spot where you may not have the retirement funds you need (whereas someone many decades from retirement could theoretically take more risks, because they have more time to recover).
Managing company stock can get complicated, especially when trying to maintain the right amount of exposure to those shares that aligns with your goals and appetite for risk. Talking with a qualified financial professional with experience in equity compensation strategies can make a complex issue much less overwhelming, by providing a straightforward strategy to give you peace of mind you’re doing the right thing with your shares.
This material is intended for informational/educational purposes only and should not be construed as investment, tax, or legal advice, a solicitation, or a recommendation to buy or sell any security or investment product. Hypothetical examples contained herein are for illustrative purposes only and do not reflect, nor attempt to predict, actual results of any investment. The information contained herein is taken from sources believed to be reliable, however accuracy or completeness cannot be guaranteed. Please contact your financial, tax, and legal professionals for more information specific to your situation. Investments are subject to risk, including the loss of principal. Because investment return and principal value fluctuate, shares may be worth more or less than their original value. Some investments are not suitable for all investors, and there is no guarantee that any investing goal will be met. Past performance is no guarantee of future results. Talk to your financial advisor before making any investing decisions.
