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.