Company Stock: What is a Concentrated Stock Position?

Morgan Ranstrom |

Many corporate and tech employees accumulate a great deal of employer stock via Restricted Stock Units (RSU), Incentive Stock Options (ISO), Non-Qualified Stock Options (NSO) and Employer Stock Purchase Plans (ESPP). At what point does your ownership of company stock turn into a concentrated stock position? More, what are the risks and rewards inherent in owning a concentrated stock position?

In this episode of Coffee, Sweaters, and Finance!, Morgan Ranstrom, CFA, CFP®, a financial planner at Trailhead Planners and Bill Mulvahill, CFP®, CPA, a financial planner at Essential Wealth, discuss the ins and outs of company stock, concentrated stock risk, and diversification. 

Questions that come up: 

  • What is concentrated stock? 
  • How does an individual come to own a concentrated stock position?
  • How does company stock impact your financial plan?
  • What are the risks inherent in owning a concentrated stock position?
  • What are the opportunities inherent in owning a concentrated position in company stock?
  • What's the number #1 thing to consider when you have a concentrated stock position?

Transcript:

Morgan :                           00:12                   Welcome to the inaugural episode of Coffee-

Bill:                                     00:16                   Sweaters-

Morgan :                           00:17                   ... & Finance.

Bill:                                     00:18                   ... Finance.

Morgan :                           00:19                   I'm Morgan.

Bill:                                     00:20                   I'm Bill.

Morgan :                           00:22                   Today we're going to be talking about company stock. We've got a series of videos and company stock actually that we'll be shooting today.

Bill:                                     00:27                   Absolutely.

Morgan :                           00:28                   The first one is concentrated stock, and so we're talking about the risks and rewards of owning concentrated, company stock, in most cases. Bill, what is concentrated stock?

Bill:                                     00:41                   Well, it is what it sounds like. It's when you hold a large position in one stock. As opposed to just a diversified portfolio, there's one stock that comprises a large component of it. And it usually comes about in one of two ways. One, you either inherit it. Two, you get it from your employer, and they grant it you through restricted stock, stock options, and so forth.

Morgan :                           01:02                   Yeah, absolutely. And I might want to just add that a family business could be part of that. Or a business that you started.

Bill:                                     01:07                   Absolutely.

Morgan :                           01:07                   Something like that, that could also be considered-

Bill:                                     01:09                   And all three of those have unique characteristics to them, unique planning dynamics, tax issues and so forth that you always want to be mindful of when you're planning.

Morgan :                           01:17                   Sure. So that kind of gets into our next question, is how does owning concentrated stock impact your financial plan?

Bill:                                     01:24                   Well, it impacts in a lot of ways. First of all, when you have so much of your net worth in one position, you want to be mindful of the risks it exposes you.

Morgan :                           01:33                   Yes. Yeah.

Bill:                                     01:35                   When you make purchase decisions, lifestyle decisions, financial decisions, you have to be mindful that you have a risk in your financial plan. You don't want to subject your goals and your lifestyle to that risk in a way that you're not prepared for.

Morgan :                           01:48                   Right, right.

Bill:                                     01:49                   There's also tax considerations as well. All the different types of company stock have unique tax characteristics, and you want to be mindful that before April 15th hits, and before you make these decisions, so that you can try to plan around your company stock in a way that doesn't surprise you, and in fact, actually takes advantage of what [crosstalk 00:02:09]-

Morgan :                           02:10                   Yeah. We have a saying around here that April is coming.

Bill:                                     02:12                   Yeah.

Morgan :                           02:13                   Yeah. Little Game of Thrones reference.

Bill:                                     02:15                   Yep.

Morgan :                           02:15                   That's terrible.

Bill:                                     02:16                   Yep.

Morgan :                           02:16                   That's terrible.

Morgan :                           02:18                   What kind of percentage would you put on, what a concentrated stock position is? Is it 2% of your portfolio? Is it 90% of your net worth? What is this?

Bill:                                     02:27                   I think 10%.

Morgan :                           02:28                   Of net worth?

Bill:                                     02:30                   Of your net worth.

Morgan :                           02:31                   Yeah.

Bill:                                     02:31                   Yep, 10% of your net worth. There's no right answer. I think you're going to find other planners have different opinions on that, but generally 10% is a good rule of thumb. Because once it gets to that level, swings and value of that stock really impact your net worth, and impact your finances.

Morgan :                           02:48                   Sure, sure. Yeah, yeah. And have an emotional toll as well.

Bill:                                     02:51                   Absolutely.

Morgan :                           02:51                   I think we've all seen cases where, or we've both seen cases where it's 99% of their net worth, and then also, just the 10% number where it's part of a broader portfolio, or sometimes it is the portfolio.

Bill:                                     03:03                   Yeah, absolutely.

Morgan :                           03:04                   Yeah. And obviously, those are a little different discussions around each level. So the one thing that I want to talk about, is the high degree of uncertainty that comes with owning company stock. Maybe you could talk about that a little bit?

Bill:                                     03:18                   Yeah. So when you have a diversified portfolio, the markets go up and they go down, and you're going to have bad years. 2008 is a great example, the S&P 500 basically dropped and got cut in half. But those instances are more rare.

Bill:                                     03:35                   And you also can have faith that in the long run, stock market is going to do well and eventually you'll get your money back if you stick with it. It's really a matter of time. The entire US stock market isn't going to go to zero, unless ... If that happens, we have much greater problems.

Morgan :                           03:52                   Right.

Bill:                                     03:52                   But with any individual stock, any individual stock can go to zero at any time. It's a business, businesses fail.

Morgan :                           03:59                   Yeah. With an index, it's a market of stocks. So there are stocks going up and down all the time, even if the market as a whole is in a bull market.

Bill:                                     04:08                   Yeah, yeah. And even if-

Morgan :                           04:10                   That could be your company.

Bill:                                     04:11                   Yeah. It could be your company, and it's, it could also have, maybe it's not going to go to zero, but it could also have a really bad performance over several years. Maybe the business is struggling. You just think of a Kodak. It took a long time for that company to eventually fail, but there was, there were many years where the performance was very poor.

Morgan :                           04:31                   Sure. Or the stock did nothing.

Bill:                                     04:32                   Yep.

Morgan :                           04:33                   Yep. Obviously scenarios like that. The one that comes to my mind is General Electric, where a few years ago, you had a lot of pensioners and retirees who had owned the stock and their 401(k) for decades, in some cases, thinking that it's always going to go up, it's a blue chip stock, it pays that dividend. And then the stock tanked. Absolutely tanked. And still has not recovered to previous highs.

Bill:                                     04:56                   It caught everyone by surprise too.

Morgan :                           04:58                   Right, right.

Bill:                                     04:58                   Nobody was expecting that. It was the one sure thing in the Dow.

Morgan :                           05:02                   Yes.

Bill:                                     05:02                   Every year they'd raise dividends. Every year, it's the blue chip company that is able to withstand recessions and so forth.

Morgan :                           05:10                   We've talked about some of the risks, how about some of the opportunities? Because obviously people wouldn't do it if there weren't opportunities as well.

Bill:                                     05:14                   Yeah. So for your, if you are a corporate professional, a corporate executive, company stock is really a great way to build wealth over time, because it's how employers start to incentivize you and compensate you once you reach a certain level in your career. So you're going to ...

Bill:                                     05:31                   Maybe it's restricted stock, maybe it's stock options. Even in the startup world, stock options are really common. So just from a compensation standpoint, that's going to be a mechanism for you to achieve higher levels of compensation, and achieve and build wealth.

Morgan :                           05:46                   Sure. We worked with a number of individuals in their 20s, 30s, and 40s who have received stock options from some of these big tech companies, or even a small tech company, or biotech, or something like that, and it can be a great way to, with a degree of hard work and luck as well, it can be a way to really create instant wealth.

Bill:                                     06:08                   Absolutely.

Morgan :                           06:08                   Yeah.

Bill:                                     06:09                   Yeah, stock options are also noteworthy too just because they have a unique structure in that they're leveraged, which, to put it simply, it means that if the stock price goes up, your stock option value can go up by even more.

Bill:                                     06:24                   So you have more upside with stock options. The counterpoint is that you also have more downside. And that's why this is all an important topic because the risk-reward characteristics are always different with company stock than just a traditional diversified portfolio.

Morgan :                           06:37                   Sure, sure. So let's kind of wrap up, with this final question. If I own, let's say 20% of my net worth is in my company stock, what are some things I want to think about in terms of maybe diversifying my portfolio?

Bill:                                     06:51                   Well, the one most important thing, is have a plan beforehand for how you're going to diversify. Whether it's restricted stock, stock options, or whatnot, make sure that you have a plan today for how you're going to sell that stock over the next two, three, five, 10 years.

Bill:                                     07:10                   When are you going to sell the stock? What are you going to use as the trigger point for making those decisions? But make that decision today, not when the stock is jumping up and down three years from now, during a, whatever the market's doing. You want to make sure you set that framework today, so that you are essentially removing your emotions from the decision.

Morgan :                           07:29                   Right, yeah. In three years whether the stock is up or down, because it's up, it's going to be hard to sell. And because it's down, it's going to be hard to sell. So there's kind of behavioral biases that come into place on both ends. So the idea is, yeah, to have this plan and make sure you're diversifying your net worth-

Bill:                                     07:43                   Absolutely.

Morgan :                           07:44                   ... to protect your family's balance sheet, regardless of what the stock does in the future.

Bill:                                     07:48                   Yeah. Absolutely.

Morgan :                           07:49                   Yeah. Thanks, Bill.

Bill:                                     07:50                   Thank you.

Morgan :                           07:51                   Like the sweater.

Bill:                                     07:52                   I love your sweater, too.

Morgan :                           07:52                   How was the coffee?

Bill:                                     07:53                   It's fantastic.

Morgan :                           07:54                   Wonderful. We will talk to you guys later. Thanks so much.

Bill:                                     07:57                   Thank you.