The Five Biggest Mistakes Employees Make with their Employer-Based Stock
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). In this episode of Coffee, Sweaters, and Finance, Morgan Ranstrom, CFA, CFP® and Bill Mulvahill, CFP®, CPA, fee-only financial planners at Trailhead Planners, list the five biggest mistakes employees make with their employer-based stock.
Questions we discuss:
- What tax mistakes do owners of company stock often make?
- What investment mistakes do owners of company stock often make?
- How much is too much when it comes to a concentrated stock position?
Morgan: 00:13 Welcome everybody to another episode of Coffee.
Bill: 00:15 Sweaters.
Morgan: 00:16 & Finance. & Finance.
Bill: 00:19 Getting better.
Morgan: 00:20 Yeah. That's good.
Bill: 00:20 Yeah. So you have a question for me?
Morgan: 00:23 I've got a question for you.
Bill: 00:24 All right.
Morgan: 00:24 Yeah, we're going to do another list today. So the list I was thinking of is the five biggest mistakes people make with their employer stock.
Bill: 00:32 Five biggest mistakes.
Morgan: 00:35 Yeah.
Bill: 00:36 Well, I'm going to start out right away with taxes. People, if they don't understand and put in the work to understand what the tax consequences are.
Morgan: 00:45 Right.
Bill: 00:46 So you've got to know when it's going to be taxed so that you can plan for it. A big thing is with company stock, a lot of times, there's opportunities to reduce your taxes if you just put in the work to plan ahead of time.
Morgan: 00:59 Mm-hmm (affirmative).
Bill: 01:00 If you understand when there's going to be an income spike, you can accelerate your deductions for that year.
Morgan: 01:04 Yeah.
Bill: 01:05 So for-
Morgan: 01:05 Remember one thing, the IRS does not care if you didn't have a plan.
Bill: 01:09 Nope, they don't.
Morgan: 01:10 Right? They didn't care. They don't care if you didn't have the information you need.
Bill: 01:12 Mm-hmm (affirmative).
Morgan: 01:13 That is not important to them. What's important to them is that you pay the taxes that you owe.
Bill: 01:16 Yep. Absolutely.
Morgan: 01:17 So you have to have a strategy for that.
Bill: 01:18 Yep.
Morgan: 01:19 Yeah.
Bill: 01:19 So number two.
Morgan: 01:20 Mm-hmm (affirmative).
Bill: 01:20 This might be a sub bullet to number one, but not setting aside money then to pay estimated payments for whenever restricted stock busts-
Morgan: 01:32 Sure.
Bill: 01:32 ... or stock options are exercised.
Morgan: 01:34 Yeah. Yeah, yep.
Bill: 01:35 You get the money, you... And they'll withhold them, but usually you're going to owe an additional amount.
Morgan: 01:41 Sure.
Bill: 01:42 You get the money and then you think, "Oh, great. I have X thousand dollars," then you go spend it on your house, or you invest it, or something like that.
Morgan: 01:49 Right.
Bill: 01:50 And then April comes around and it's like, "Hey, you owe-
Morgan: 01:52 Right.
Bill: 01:53 ... IRS X thousand dollars."
Morgan: 01:54 Government gives you the bill.
Bill: 01:55 Yep.
Morgan: 01:55 It's a little more than you're thinking.
Bill: 01:57 Yep.
Morgan: 01:57 Yeah. You don't want that scenario to play out.
Bill: 01:59 Absolutely.
Morgan: 01:59 I'm going to throw a number three if that's all right.
Bill: 02:00 Right. Let's hear it.
Morgan: 02:01 And that is not having a diversification plan.
Bill: 02:04 Yeah.
Morgan: 02:04 So often people get a stock comp, and then the stock's doing pretty well.
Bill: 02:07 Mm-hmm (affirmative).
Morgan: 02:10 And they have never had or don't have a plan for solidifying their net worth and diversifying their net worth.
Bill: 02:17 Mm-hmm (affirmative).
Morgan: 02:18 And that's where you can kind of get into a scenario like what happened to General Electric.
Bill: 02:22 Mm-hmm (affirmative).
Morgan: 02:23 Or we've seen it with other companies that the stock is at X, maybe it's been growing for five years, and then it tanks, it goes down 50, 60, 70% loss, and you wish you had diversified.
Bill: 02:35 We've talked about this before about how difficult it is emotionally to manage a concentrated position.
Morgan: 02:40 Mm-hmm (affirmative).
Bill: 02:41 The way to manage... The way to avoid that is to have a plan beforehand for how you're going to diversify.
Morgan: 02:46 Absolutely.
Bill: 02:47 And if you don't do that, I... People make mistakes all almost across the board because it's so hard to manage without a predetermined plan.
Morgan: 02:57 Mm-hmm (affirmative). Yeah. Corollarily, what would you point out as a good number where, a healthy number to have in your employer based stock?
Bill: 03:07 I like 10%.
Morgan: 03:08 You like 10%?
Bill: 03:09 Yeah. Sometimes you can't avoid having more than that. Maybe it's unvested.
Morgan: 03:13 Mm-hmm (affirmative).
Bill: 03:16 So you just naturally have a large position.
Morgan: 03:18 And sometimes for corporate execs, the company mandate is that you might have to have a certain, not necessarily of your net worth, but a certain percentage or certain amounts in company stock. Obviously that's not something you can plan around. You just have to own it.
Bill: 03:30 Yeah. So sometimes you're going to have to have more because of holding requirements.
Morgan: 03:32 Sure.
Bill: 03:33 Sometimes there's expectations that are set in terms of how much you hold. Sometimes it's unvested.
Morgan: 03:37 Mm-hmm (affirmative).
Bill: 03:39 And stock options are a little unique, sometimes it makes sense to hold those longer.
Morgan: 03:42 Mm-hmm (affirmative).
Bill: 03:42 But yeah, I like 10% in general if you can try to get it down to there.
Morgan: 03:45 Yeah. Yeah. And for me, the rule of thumb, I always thought of this is 5 to 10%.
Bill: 03:49 Yeah.
Morgan: 03:50 It's somewhere in that number. Anytime you start getting over 10, that becomes a disproportionate amount of your net worth.
Bill: 03:54 Absolutely.
Morgan: 03:54 So what would be number four?
Bill: 03:56 All right. Stock options.
Morgan: 03:58 Mm-hmm (affirmative).
Bill: 03:59 See people exercise them too early. So stock options are-
Morgan: 04:03 So what happens then?
Bill: 04:04 Stock options are a little unique from other types of employer stock because of their structure. They're leveraged, which means the structure inherently is leveraged, which means that if the stock price goes up, the options is going to go up by more.
Morgan: 04:18 Mm-hmm (affirmative).
Bill: 04:18 There's more risk, you can lose the value faster as well. But that's leverage that you can use to your benefit.
Morgan: 04:25 Yes. Right.
Bill: 04:26 And the key there is making sure that you generally want to hold them longer because it allows you to maximize then for though to hold that leverage than traditional employer stock.
Morgan: 04:37 Yeah.
Bill: 04:37 So a lot of times I think people see in the money value and their stock options and they... Whether it's-
Morgan: 04:46 They want to pull that trigger.
Bill: 04:47 They want to pull the trigger, they want the cash.
Morgan: 04:49 Absolutely.
Bill: 04:50 And if you have, it depends on... Everyone's going to be different. So it depends on what type of equity you have.
Morgan: 04:55 Mm-hmm (affirmative).
Bill: 04:56 But if there's ways that you can diversify while ideally holding your stock options for the optimal amount of time.
Morgan: 05:02 Sure, sure.
Bill: 05:03 There's always a balance there.
Morgan: 05:04 Yeah. And this just kind of comes back to having a plan. You get must have a plan.
Bill: 05:09 Yep.
Morgan: 05:10 Yeah. I'm going to throw a number five if that's okay.
Bill: 05:12 Let's see it.
Morgan: 05:13 And that is ignoring the rest of your financial life.
Bill: 05:16 Yes.
Morgan: 05:16 I think so often when a certain asset, even if it's just your house, or a business that you own, or obviously in this case a company stock, takes on a disproportionate amount of your net worth or your financial life, it's common to kind of forget about everything else. Right? And so often in our clients with a loan company stock, we see them kind of forgetting about their cashflow or forgetting about their taxes, or forgetting to put money in the 529s, or even tax maximize their 401k. Is that where you're going right there?
Bill: 05:47 Yep.
Morgan: 05:48 Yeah. We see that all the time where they're so focused on the ISOs, RSUs, something like that.
Bill: 05:52 Or they're not even employer stock purchase plans.
Morgan: 05:54 Sure.
Bill: 05:55 They're so focused on all these things.
Morgan: 05:55 Sure.
Bill: 05:56 And they're missing basic fundamental planning opportunities that are right there in front of them because they're so obsessed about trying to hold their stock to the right moment in time, or whatever.
Morgan: 06:10 Right. And no shame here.
Bill: 06:12 Yeah.
Morgan: 06:12 Yeah. It's just the way that we think. We kind of tend to... Our brains attract, are attracted to what's biggest in that sense. And... But that's something we see over and over. So forgetting about the rest of your financial life, obviously we want to give attention there too, because that matters.
Bill: 06:29 Absolutely.
Morgan: 06:29 Yeah. Anything else, Bill? I don't have a bonus question today.
Bill: 06:33 That's it.
Morgan: 06:33 I don't do bonus, I don't really like them. You can do it.
Bill: 06:35 Oh, yeah. Both... I don't have any right now.
Morgan: 06:38 Okay.
Bill: 06:38 But those are all big things that I think we'll probably circle back on them again at some point.
Morgan: 06:41 Awesome. Awesome. All right. Thanks y'all.