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With the tech world booming, receiving a bundle of stock options and other types of equity compensation seems like a great perk. But beware of letting your portfolio become too heavy with your company’s stock. You can have too much of a good thing.
Think of your job as an asset
Your most important asset over time is actually your job. The income you receive from it is, of course, tied to your employer, as is your benefits package, including health insurance, your retirement plan and so on. So if you are receiving equity compensation of any sort and holding on to all of it, you are essentially doubling down on the success of your own company. When a bear market hits, it is common for layoffs and tumbling stock prices to go hand in hand. If you lose your job, and thus your income, you could find that your stock doesn’t give you much of a cushion to land on while you look for another job.
Don’t get cocky
Granted, you may feel you have an expert view of your company and will know when things are going south. But you might not be in the C suite — and even if you are, that’s no guarantee of foresight. Industrywide trends can drag your company’s stock down, too. Furthermore, we know from behavioral finance that there is a bias toward confidence in areas we are familiar with, which can actually make it harder for insiders to accurately predict where stock prices will go.
Watch your percentage
We recommend calculating what percentage of your investment portfolio is tied up in your company’s own stock. If you don’t have a lot of confidence in your company, you might want it to be only 5% to 10%. If you’re more bullish, then maybe even up to 25%. We can’t see much benefit to holding more than 25% of your portfolio in your company’s stock because of the doubling-down risk.
Make diversification a priority over taxes
Once you’ve decided upon a percentage, you can develop a plan to move your excess money out of your company’s stock and diversify into a portfolio that will greatly reduce your individual company risk. Of course, you’ll want to look at the tax effects of any decision, but we think that in the long run, it’s more important to have a diversified portfolio than to avoid the short-term tax implications of trading. Consult your tax preparer for more information.
Optimize the time value
Are you holding a lot of stock options? There is a time value tied up with the market value of those options. At a certain point in the life of your options, the premium for continuing to wait before exercising starts to diminish. For people with large option portfolios, it is really worth consulting with a financial advisor who can review your holdings and advise you on when and how to exercise the options.
Don’t let yourself be caught double exposed to the risks associated with owning too much company stock. Does your financial plan look like the closet under your staircase? Put yourself on the road to financial success by joining the Mosaic Financial Fitness Challenge.
This post first appeared on Nasdaq.
Image via iStock.
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