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AFTER ENRON’S COLLAPSE in 2001, there were numerous articles about employees who had most of their money in the company’s stock and how they’d lost it all. Taking that message to heart, I’ve endeavored to keep our holdings of my company’s stock below 10% of our net worth. I must confess, however, that in good times it’s crept up to 15%—and in bad times it’s fallen to zero.
I can’t claim any particular insights or novel thoughts on how to manage company stock. I’m willing to share what I’ve done, however, and let you decide how to handle your situation.
My company stock came from three main sources: the employee stock purchase plan, the match on my 401(k) contributions, and the stock options or restricted stock awards received as part of my annual compensation. As you’ll see, these three stock programs represent the good, the bad and the ugly of my investing career.
The employee stock purchase plan was the good. In our plan, we were allowed to divert up to 10% of our salary to company stock. The best part was that we could buy the stock at a 15% discount to current market prices.
Early in my career, there was a machine operator who was retiring. The word in the factory was that he was wealthy. He had been stashing 10% of his pay in company stock for the past 45 years. He had never touched the shares. I’m sure his retirement was much more comfortable than that of most machine operators.
I also spent my first five years at the company not touching the stock. We then sold it to make the downpayment on our house. Shortly thereafter, I decided I needed to rethink how to handle the stock purchase plan so I wasn’t overly reliant on the company.
For about 20 years, I was able to sell the stock after holding it for only a month. I would purchase the stock one month at a 15% discount and sell it the next month. I always made money. Depending on the market, sometimes I made more than 15% and sometimes less.
Some coworkers would scold me, telling me that I should hold the stock for a year to qualify for the lower long-term capital gains rate on my profits. My reply was that—depending on how you do the math—I was making an annualized return of as much as 603%, so I was happy to pay the ordinary income-tax rate. (For math nerds, a 15% discount is equal to an immediate 17.6% monthly gain on the purchase price. Compounded over 12 months, that comes to 603%.)
Some would look at me blankly, saying that I was only making 15%. When I couldn’t convince them that I was making far, far more than that on an annualized basis, I’d offer to lend them all the money they wanted at 5% a month. None of them took me up on the offer.
Eventually, to encourage long-term investing, the company changed the rules and required a year-long holding period before selling. At the end of the year, rather than selling, we’d donate the shares we’d purchased to charity, thereby avoiding any taxes on the gains.
For a while, the company paid its 401(k) matching contribution in company stock, which meant we had an ever-increasing exposure to this single stock. Shortly after Enron blew up, my employer stopped paying the match in company stock, while also allowing us to sell whatever company stock we had in our 401(k) and invest the money in one of the plan’s mutual funds.
I promptly traded half my company stock for shares in a broad-based mutual fund. Why only half? I’d heard about the tax advantages of net unrealized appreciation of company stock held within a 401(k). Executed correctly, when you sell, you pay income taxes on the original cost basis of the stock but the lower long-term rate on any gains. I thought that in 20 years, when I retired, this would be a good deal.
Fast forward 20 years. I was planning on withdrawing my company stock from the 401(k). Remember the good, the bad and the ugly? This is where we get to the bad. First, the stock had fallen in price, dramatically reducing both its value and the strategy’s tax advantages.
Second, I read research by financial planner Michael Kitces suggesting that if you plan to own company stock for the long term, you’d be better off buying it outside the 401(k) to obtain the more favorable long-term capital gain rate on the whole investment and not just on a portion of it. I decided to sell all my shares and diversify using mutual funds in my 401(k). In hindsight, I realize I should have done this much earlier.
What about the ugly? That’s been the performance of my company stock options. Part of my compensation was “at risk” compensation. We were able to take this as either restricted stock units, which is a grant of shares at some future time, or as stock options, which would have value only if the shares achieved a specified price in the future. According to my employer, the value of either award was calculated to be the same when they vested in three years.
Every year, when it came time to choose how to receive this compensation, there would be lots of discussion about which was the better choice. When asked my opinion, I always said that what I was planning to do wasn’t appropriate for all people, but I’d be taking all my shares in stock options.
I had 20 years of data going back to 1978 showing that, if you held the stock options until they expired in 10 years, they performed significantly better than the restricted stock units. I planned to use my stock options as income during the 10 years following my retirement at age 60, and then claim Social Security at age 70.
I’m retired now and my remaining stock options are worth exactly zero dollars. Some may be worth money in the future if the company’s shares rise, but the hoped-for income stream from the stock options has vanished. Fortunately, I saved and invested well enough so I won’t have to claim Social Security before 70.
Although my stock option decision didn’t play out as planned, the poker player Annie Duke cautions people to not confuse the results with the decision-making process. In other words, you can be right and still lose money. I believe that my process was sound. I knew there was a potential for the options to be worth nothing and so, while it’s disappointing, it’s a financial setback I was prepared for.
While there are lots of valid ways to treat company stock, my advice would be to limit the value of your company stock to 10% or less of your total portfolio. As I’ve learned, company stock is a concentrated investment—and you may not be rewarded for the extra risk you run.
Kenyon Sayler is a retired mechanical engineer. He and his wife Lisa are extraordinarily proud of their two adult sons. He enjoys walking his dog, traveling, reading and gardening. Kenyon’s brother Larry also writes for HumbleDollar. Check our Kenyon’s earlier articles.
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I was CFO of several private equity owned businesses. A significant portion of my compensation was in company stock, either RSU’s or options. I was also offered the opportunity to invest more in company stock at various times. Privately owned companies are a risky investment as the stock option or RSU is not based on market price but a “valuation.” A valuation could be done internally, by the owner (private equity) or by a third party. Several of my businesses had worthless equity at the time I left the business. Several paid off handsomely. I never lost money on the cash I put in but I know folks that did. I would always suggest to not invest money you can’t afford to lose.
Prior to my private equity experience, I worked for two large public companies that had stock options and stock as an investment option in their 401K. I was heavily invested in comapny stock in both companies. I always felt I had a good feel for the company financials and could manage the risk. I exited the company stock investment immediately upon leaving the company and invested the proceeds in index funds and bonds.
I can’t emphasize enough the importance of diversification! Your job is an investment in your company, likely your biggest investment. I started working for a F500 Telco with a $20B market cap 6 years ago. They’ve paid me a good salary (even if not as much as I’d have liked all the time) and benefits. But in the last 6 years, the stock is down 90% and removed from the S&P500, and thanks to the recent WSJ lead cable studies, the fact my RSUs are nearly worthless weighs far less on my mind than the fact that, if the company declares chapter 11 my job could be in jeopardy. I think we’re oversold, but I won’t touch the stock–the risk of being wrong is WAY too high.
My employer, Delphi, had a decent match for our 401k. However, the matching money was in company stock, and we had to put half of *our* contribution into company stock (up to the amount that got matched). The holding period was for two years from the end of each year, so effectively between three and two years (for contributions in January through December). So, people could get out from owning excessive amounts of DPH stock, but inertia kept many from doing so. Although there was a match, other companies had more of a match; what we got seemed pretty good on top of the pension included in our benefits package.
Then in 2005, Delphi went bankrupt. The price of the stock went to a few pennies. It seemed worthwhile to hold on to the stock “just in case” it could be rescued from worthlessness, But, it turned out we didn’t own stock–we owned a “comingled fund” whose assets were only in DPH stock. So, that “fund” sold the stock for next to nothing without any fund holders’ agreement. Even those who tried to minimize how much company stock they owned were hurt pretty bad.
When GM went into bankruptcy in 2009, the federal government stepped in to save the pensions of both the salaried employees and the hourly employees. They used that opportunity to also save the pensions of the Delphi hourly employees, leaving only the Delphi salaried employees to have their well-funded pension turned over to the PBGC. The Delphi Salaried Retirees Association is still fighting–14 years later–to get their earned benefits restored.
I’m happy to say that my former employer never paid its 401k match in stock. I’m not even sure that company stock was a plan option. You also had to be way high on the org chart to get stock options.
There was an Employee Stock Purchase Plan, and I did participate for a few years. I quit when the company flirted with bankruptcy (well before Enron) and I realized that holding stock in the company that paid my salary, provided my medical care and would (hopefully) pay my pension was too risky. The stock recovered, but every time it split I sold the new shares. The few I still hold are worth less than the last ones I sold, although they are still paying dividends.
I was given several hundred dollars of company stock early in my career and ended up putting it in my 401(k). Ten years later it was worth north of 15K. It stayed pretty flat after that. During a recent company split, I had to make a decision on the stock. I ended up selling it and putting the proceeds into a more conservative fund. Too bad. The new company stock which I could have received doubled in value last year. Still think my reasoning was fairly sound, but will admit it stung a bit as I saw my own company’s stock rise so fast after I exited the game.
Good review of the company stock issue.
I used to manage executive compensation so I heard many discussions you refer to. Our company matched 401k with company stock too until Enron. I remember the day that hit the news. I went straight to the Chairman’s office and we decided to make matches in cash thereafter.
As a 401k administrator we constantly cautioned workers about having too much in company stock. Nevertheless, there were those who had 100% in company stock. At times it was hard to make the argument to them as that option was the best investment in the plan.
‘I took a different tact with my stock based compensation. Except for some options from my first grant I used to remodel our house, I took all options exercised and restricted shares in stock.
The dividends have been reinvested for nearly twenty years and the stock has risen in price about 50%. This is a utility company so growth is limited. In any case, if I need to turn off the reinvestment, the dividends will give me around a 10% income boost. But I probably still have too many eggs in one basket.
“his retirement was much more comfortable than that of most machine operators.”
Many folks would be stunned at the money a machine operator makes when working for a good company.
I knew a few blue-collar workers who delighted in making salary people aware that the shop floor made more money than the office. One person “accidentally” left his paystub on the engineering office copier. Not classy and not advisable, but very true via high wages and overtime pay.
Agreed. Although I think there was a pretty strong correlation between amount of OT and the divorce rate.
lol, that seems to be the case
I worked closely with unions and union workers and I was frequently impressed with the investment skills and knowledge many of these folks had. It often far surpassed the workers in the ivory tower as they used to call the general office. I learned a lot from these workers who some in management looked down on.
I think the fancier the college degree an individual has, the more underwhelming their stock returns. Wall Street thrives on picking the pockets of those smarty pants investors.
There are so many “Annie Duke moments” with stock compensation. My latest: I bought put options to limit our exposure to big drops in my former employer’s stock over the next 18 months as grants vest. The income is a key part of our Social Security deferral plan. Like other insurance spending, I hope they aren’t needed but sleep better knowing our plans won’t go up in smoke if Mr Market gets cranky.
Excellent article. I’m past the point where this will be helpful to me, but I wish I’d read it 40 years ago early in my career. I particularly liked your citation to “not confuse the results with the decision-making process”. Years ago during a contract transition I had to make an employment decision. A few years later it was clear I had made the wrong choice. However, I took great comfort from the fact that with the data I had at the time, I had made the best decision at the time. Only with the clarity of hindsight was it clear to not have been the best decision. In this life that’s about the best we can do sometimes.