Tech compensation – Company stock (options)

I live close to “tech land.”  Amazon headquarter is about 25 miles north in Seattle, and Microsoft headquarter is about 40 miles northeast in Redmond.  The large pool of typically young, technical talent has attracted satellite offices of Bay Area tech giants, such as Google and Facebook.  It’s also responsible for the vibrant entrepreneurial community behind a number of more recent disruptive technologies: Redfin, Rover, Convoy, Tableau Software, etc. 

 

To gain and maintain their competitive advantage, many tech companies leverage their company stock (options) to attract and retain employees, who often have to work in a fast-paced, demanding environment.  Company stock (options) are often given out via sign-on bonus, performance review, employee stock purchase plan (ESPP) and/or a combination of.  Many tech employees refer to their company stocks and accompanying generous employee benefits as “golden handcuffs” – cushy, but often at a high, personal cost.  Consequently, it’s not uncommon for tech workers to amass a sizeable portion of their investment portfolio in company stocks.  Additionally, it seems as though many only start thinking seriously about divesting around or soon after their departure from their employer. Is this financially wise?  

 

Company stocks – Pros and cons

As with any big life decisions, when deciding when and how to divests your company stocks, it’s important to weigh the pros and cons for holding versus divesting.  

·      Hold – Pros 

    o    Ownership and responsibility/incentive.  By holding equity stake in the company, you may be more motivated to help ensure its success as you’re a part owner.  

    o    Potential windfall.  Should your company deliver on key financial targets (e.g., quarterly earnings, new customer acquisition), you stand to receive a windfall. 

    o    Insider information.  As a company employee, you’re probably more knowledgeable about the company’s (true) prospects than outsiders.

·      Hold – Cons

     o   Lack of diversification; high concentration in one company stock.  You’re exposed to company-specific risks (e.g., product/service launch, incompetent management), which are unique to your company.  Risks are not offset by the performance of other companies as is the case with mutual funds and exchange traded funds (ETFs).   

  o  Double financial exposure as employee and investor.  Should your company encounter trouble and/or fail, you could lose both your income (job) and a good portion of your savings (company stocks). 

    o   Lack of objectivity.  As a company employee, you may be too close to the situation and can’t evaluate it objectively given your big stake in its success.   

·      Divest – Pros

  o   Diversification; lessen risk.  By selling a portion or all of your company stocks as you go, you potentially limit your upside, but also (critically) your downside.

    o    Greater financial flexibility and tax management.  Divesting and reinvesting company stocks/proceeds, gives you more flexibility in: 1) selecting and changing                 your investments 2) realizing capital gains tax in a more efficient way.       

·     Divest – Cons   

  o   Fear of Missing Out (FOMO).  Should your company continue to succeed, you potentially lose out on the additional upside via your company stock.  Equally painful, you have to hear about coworkers winning it big.  

 

Company stocks – Balancing risks and returns  

When it comes to company stocks, the general rule-of-thumb is to hold no more than 10% of your overall portfolio.  If your company stock falters, the lost would be painful, but not catastrophic.  However, as with most things, balancing risks and returns depends on your personal situation, risk capacity and risk tolerance level, which is typically difficult to gauge until confronted with a bear market when it’s likely too late.

 

One way to determine how much to hold in company stocks is by gauging the financial impact such a lost would have on your finances.  For example, let’s say that Tammy tech worker (age 50) is considering early or semi-retirement.  She currently has a $1,000,000 portfolio, half of which is her company stocks (brokerage account).  Tammy wants to withdraw $40,000/year from now until Medicare (age 65) and Social Security (age 70 – maximum benefit).  The table below shows the impact on her annual withdrawal should her company stock decline.

 

Decline of Company Stock Value	Value of Company Stocks (Ending)	Value of Other Investments	Total Portfolio	Potential Annual Income Withdrawal (4%)
0%	$500,000	$500,000	$1,000,000	$40,000
20%	$400,000	$500,000	$900,000	$36,000
40%	$300,000	$500,000	$800,000	$32,000
60%	$200,000	$500,000	$700,000	$28,000
80%	$100,000	$500,000	$600,000	$24,000

 

At which point does the decline become too uncomfortable – financially and psychologically – for Tammy?  If a 40% decline in company stock is too much for her, then she should have a strategy for diversifying $300,000 of her company stocks to limit her portfolio’s downside.  Doing so will help her hold onto her investments versus sell in a panic during a bear market.    

 

Company stocks – Pushbacks on divestiture  

Given the financial downside, it’s not uncommon for many tech workers to pushback on divesting their company stocks.  Here are some of the typical reasons against divestiture. 

·      Tech company X’s stock has been very good to me.  I see more upside.    

·      Tech company X is a large US blue chip and will recover from a bear market.

·      I work at tech company X and have a far better understanding of its risks/returns versus those of other companies.

·      I’m still young (20s and 30s) and can recover financially if tech company X’s stocks tank.    

 

But, I suspect the biggest reason for not divesting: inertia.  

 

Conclusion  

When evaluating the financial impact of company stocks, it seems like many tech workers have a tendency to weigh the upside more heavily than the downside.  Unfortunately, it’s typically during a bear market that the downside comes into focus.  Holding a high portion of your portfolio in your company stocks is similar to buying stocks on margin.  You double your upside, but you also double your downside. Additionally, the massive run-up in US large-cap growth stocks (mostly tech stocks) over the past 10 years has inversely increased their potential downside.  As is, now may be a good time to reevaluate and rebalance your portfolio.  If you cannot survive the downside, then you probably won’t be around for the upside.