Make a financial plan for your company stock and other assets
Decide what level of risk is optimal for you and your financial goals
Contact your company’s HR department to understand the stock-trading rules that apply to you
With stock investments, the importance of diversification can be summed up with a common saying: “Don’t keep all of your eggs in one basket.”
Understandably, employees with stock compensation who are loyal to their company and optimistic about its future may want to hold the shares they receive from their grants. However, remember that the purpose of investing is to help you reach your financial goals. As with the basket full of fragile eggs, it can be risky to keep all or most of your net worth in just one stock. When your investments are spread over many different stocks, the total value of your holdings is less vulnerable to a sudden dramatic decrease in any single stock price.
The stability that comes from investment diversification can potentially help achieve financial goals. This article presents some points to consider about diversifying holdings of company stock acquired from equity compensation.
Diversification Is Not Disloyal
You may feel that you face a dilemma: company loyalty versus sound investment diversification. How do you decide on the right amount of company stock to keep and the right amount to sell and invest elsewhere?
Most employers want you to make the most of your stock compensation, both as a reward and as a motivator. Diversification can help maximize value acquired from a company stock plan. Just as you sometimes need time off from work to recharge and perform your best in your job, sometimes diversifying out of your company’s stock can help realize the full benefits of your company’s equity awards. Taking care of yourself so that you can do your best is not disloyal—it’s in everyone’s interest! Diversification can be a key part of your investment strategy.
Taking care of yourself so that you can do your best is not disloyal—it’s in everyone’s interest!
Review Your Eggs And Your Baskets
Make a financial plan that includes setting goals for your company stock and other assets. That starts with clearly understanding your investment positions. Just as you know medical facts about yourself, you should understand basic factors in the health of your investments and how they relate to financial goals.
Periodically, perhaps with the help of a financial consultant or advisor, review your asset allocation. Think of it as your number of baskets and the number of eggs in each basket. In general, you want to distribute those eggs evenly; however, that may change depending on your stage in life or financial needs. The more you have in just your company’s basket, the more vulnerable your portfolio is to that one stock price.
If your company stock does not perform well, time will magnify that impact. Diversification typically leads to more stable overall returns. In a study of stock performance by S&P 500 companies over 4 years, the median company underperformed the index by roughly 2.5% over 1 year, 5% over 2 years, and by more than 10% over 4 years. However, just as some stocks lose value, others gain value, so diversification tends to help offset decreases with increases.
The simple chart below is a basic, easy-to-use tool with which you can summarize the percentage of your net worth in company stock.
Download the worksheet
Find A Level Of Risk You Are Comfortable With
All investing involves risk. You need to decide what level of risk is optimal both for getting returns that allow you to pursue your financial goals and for keeping your peace of mind. The general rule of thumb is to limit your position in any one stock, e.g. your company’s stock, to 10%–15% of your overall portfolio.
Look at your company stock’s history of increases and decreases, termed volatility. You can get a sense of how volatility affects your personal wealth if you multiply the percentage of increase or decrease by the percentage of your net worth in the company’s stock. Compare your company stock’s volatility to that of other stocks. Because stock prices in whole industry sectors can move in unison, be sure to consider investments outside your company’s sector.
Understand Tax Consequences
Learn the tax consequences of selling shares to diversify. These include your rate of capital gains tax (15% or 20%, depending on your yearly income) and whether your income triggers the Medicare surtax on investment gains (3.8%).
Find out any ways you can mitigate tax impacts. For example, capital-loss carry-forwards from any unused losses in prior years can offset capital gains that you generate from stock sales. You may need to contact a tax advisor for help with your specific situation.
Ready to take your company’s equity compensation plan to the next level?
Know Your Company’s Stock-Trading Rules
Before you sell shares to diversify, be sure that you are permitted to do so by the securities laws and by company rules. If you frequently possess important confidential information about your company that will move the stock price when it is made public, there will be periods when you are not allowed to trade the company’s stock, as doing so could result in legal consequences. Depending on company rules, you may need to pre-clear any trades and may be allowed to sell only during specified trading window periods. Your company may also have stock ownership guidelines, based on your position, that need to be considered before selling stock.
Contact your company’s HR department to find out the stock-trading rules that apply to you. Don’t wait until the last moment. Part of implementing your financial plan is eliminating the potential for unpleasant surprises at times when you need to take action.
Checklist Of Actions
- Make a financial plan for your company stock and other investments.
Set goals for the use of your company stock proceeds.Do regular financial checkups.Find your comfort zone for ownership percentages and gauge your company’s financial results.If necessary, rebalance your investments to diversify your portfolio.
To help, schedule a goal-planning session with a TD Ameritrade Financial Consultant.
This article was developed in partnership with mystockoptions.com.