In the above video from CNBC’s Halftime Report, Sand Hill Chief Investment Officer, Brenda Vingiello, CFA discusses how to approach the market volatility. You areread more
Concentrated Stock: Where Company (Stock) Loyalty Can Be a Risk
Awards of company stock in any form are a meaningful and commonplace way for employers to compensate their valued employees beyond their regular salaries. But all too often — as a result of this generally welcome benefit — we see investors accepting too much personal financial risk by carrying oversized concentrations of the common stock and/or stock options of their employer.
Company stock can be awarded in a variety of ways:
Employer Stock Purchase Plan: periodic offerings of company stock, whereby the employee purchases shares, often at a discount, to the current market price.
Restricted Stock Units: an increasingly popular form of equity compensation whereby the employee is awarded shares of company stock that vest over a set period of time.
Stock Options – either Incentive Stock Options (ISO) or Non-Qualified Stock Options (NSO or NQSO): another common form of equity compensation in which the employee is awarded the right to purchase stock at a pre-determined price. Note: there is an out-of-pocket cost to the employee to exercise these stock options, as well as various potential tax implications that need consideration.
Generally speaking, portfolio diversification is a good way to mitigate investment risk. Too much of a good thing can be, well… too much. Over the years, long-time employees may accumulate large holdings of their employer’s stock, or stock options. If they don’t practice some sort of selling discipline of at least some of their holdings after they vest — and diversifying such proceeds into other investments — employees could find themselves over-exposed to their employer’s fate. This increases the risk of suffering substantial personal financial loss if the company’s stock suddenly underperforms. Many times, the employee may simply be frozen in the decision-making process because of the complexity of these stock and option ownership methods.
The development of any sensible diversification strategy requires thorough analysis of the tax impact of selling versus the benefits of diversification, how much to divest, immediate versus staged selling, and alternatives to selling such as hedging techniques or possible direct donations to charitable vehicles. There are also differences among the types of stock options involved when considering the potential tax treatment at exercise and/or sale. It’s critical to know the difference and incorporate careful diversification planning, since there might be ways to mitigate related tax consequences. All future anticipated stock awards should also be considered in the overall analysis and planning, plus the timing of all scheduled vesting dates.
Loyalty to one’s employer or team is a typical motivation to hold onto company stock. Sometimes, a certain holding size of shares is expected or even required. If this sounds familiar, there could be creative ways to satisfy these conditions without subjecting your personal wealth to excessive financial risk.
If you have a concentration of company stock in your 401(k), there may be a solution in a strategy called Net Unrealized Appreciation (NUA). Please see our previous blog commentary on NUA.
Before selling, though, it’s imperative that you consult your company’s stock plan administrator. If you are an officer of the company, a member of the Board of Directors, or a consultant or contractor who receives access to material non-public information in the course of your work with the company, then you will be subject to certain restrictions around trading activity. You may need to seek pre-approval for trading, and/or file Rule 144A documents, and/or adhere to open trading window requirements. Great care should be taken with regard to selling any such restricted company shares in order to avoid violating federal and state securities law and company policies.
Of course, all of these potential concentration outcomes are, basically-speaking, “good problems to have”; however, consider if your employer were to give you a $50,000 cash bonus, would you simply turn around and buy $50,000 worth of your company’s stock on your own? Your answer would probably be “no”. By not routinely liquidating company stock (and diversifying your wealth) as it is awarded to you and instead allowing a concentration of stock to accumulate (sometimes unwittingly), this is essentially the same thing.
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