The Risks Of Employer Stock

One of the biggest risks I’ve seen lurking in people’s investments is having too much in a current or former employer’s company stock. What’s too much?

Rule of thumb

You should generally have no more than 10-15% of your investment portfolio in any single stock. Keep in mind that an investment adviser can lose their license for recommending more than that.

More than just a stock when it’s your job

So why is this such a bad idea? What if your company stock is doing really well? Well, it’s been a while but remember, Enron anyone? While it’s practically impossible for a well-diversified mutual fund to go to zero, that could easily happen with an individual stock. In that case, you could be out of both a job and a good bulk of your nest egg at the same time.

Now, I’m not saying your company is the next Enron. In fact, it could be perfectly managed and still run into trouble. That’s because you never what effect a new technology, law, or competitor can have regardless of how good a company it is.

Nor does the company have to go bankrupt to hurt your finances. Having too much in an under-performing stock can drag down your overall returns and even a well-performing stock can plummet in value just before you retire. As volatile as the stock market is as a whole, it’s nothing compared to that of an individual stock.

Why do we over-invest in our own companies?

So why do people have so much in company stock? There are two main reasons. Sometimes, it’s inadvertent and happens because you may receive your employer retirement plan matching contributions or other forms of compensation in the form of company stock or options. Other times, it’s because people may feel more comfortable investing in the company they work for and know rather than a more diversified mutual fund they may know little about.

My general guideline is to minimize your ownership of employer stock. After all, the expected return is about the same as stocks on a whole (everyone has an argument about why their particular company will do better just like every parent thinks their child is above average) but as we’ve already discussed, the risks are greater. That being said, there are some situations where it can make sense to have stock in your company:

When it might make sense to keep more than usual in company stock

1) You have no choice. For example, you may have restricted shares that you’re not allowed to sell. In that case, you may want to see if you can use options to hedge the risk. This can be complicated so consider consulting with a professional investment adviser.

2) You can purchase employer stock at a discount. If you can get a 10% discount on purchasing your employer’s stock, that’s like getting an instant 10% return on your money. If so, you might want to take advantage of it but sell the shares as soon as you can  and make sure they don’t exceed 10-15% of your portfolio.

3) Selling the stock will cause a huge tax burden. Don’t hold on to a stock just because you don’t want to pay taxes on the sale but if you have a particularly large position, you may want to gift it away or sell it over time. If you do the latter, you can use the same hedging strategies as above.

4) You have employer stock in a retirement account. This is a similar tax situation because if you sell the shares, you’ll pay ordinary income tax when you eventually withdraw it. However, if you keep the shares and later transfer them out in-kind to a brokerage firm, you can pay a lower capital gains tax on the “net unrealized appreciation.” (You can estimate the tax benefit of doing so here.) In that case, you may want to keep some of the shares but I’d still limit it to no more than 10-15% of your total portfolio.

5) You have a really good reason to think it’s a particularly good investment. For example, you work at a start-up that could be the proverbial next Google. It may be too small of a company for analysts to cover so it may truly be a yet-to-be-discovered opportunity. In that case, go ahead and get some shares. You may strike it rich. But remember that high potential returns come with high risk so just make sure you’ll still be financially okay if things don’t pan out as hoped.

The ups and downs of the stock market typically gets all the media and attention. But your greatest investment risk may come from just one stock. Don’t put all your eggs in it.

 

 

 

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