By: Brandon Harvey, Founder / Family Wealth Advisor, Legacy Wealth Management Group
As part of my blog series, I’ve decided that I will write a blog about an issue that I come across regularly in my experience as a financial advisor. The topic for the month is stock compensation, and how to best approach it as part of a fit financial strategy.
In my experience as a financial advisor in the Bay Area, I cannot count how many times I’ve come across a person who claims to be a conservative investor, that also holds a large percentage of their wealth in their own company’s stock. With this region being so tech heavy, many companies draw talent with the allure of stock options or restricted stock bonuses.
I’ll put this very plainly, holding over 10% of any one stock is not a symptom of conservativism. I often tell clients stock compensation can be a gift and a curse.
Stating the obvious, being compensated in stock can give an employee a bonus that carries with it a higher potential upsidethan purely being paid in cash, and even defer taxes, in some cases. But, as we’ve seen time and time again, individual stocks can also be subject to unexpected drops due to negative news, missed earning reports and even gross negligence from employees or management.
There are many constraints that affect peoples’ decision to part with their stock. Many employees have an overriding belief in their company (thus the reason they work there). Or they may have a heavy tax obligation on a sale. Many times, they become paralyzed because they just don’t want to miss. But whatever the incentive for clients to hold onto the stock at-length, it is often at-odds with their normal risk temperament. Add in the fact that these people actually work for the same company whose stock they own, a huge piece of their lives and livelihood relies on the performance of that company.
While we’ve all heard the stories of how someone increased their wealth by millions on the back of their company’s performance. But no one is going to brag about losing a sizeable portion of their wealth overnight. Hindsight is 20/20, but who would’ve thought Enron would victimize itself through scandal; that the perennial dividend producer GE would lose nearly 80% of it’s value in a little over a year; that a revised sales expectation in China would make Apple fall 10% overnight?
Even though there may not be a clear path for all investors to take, there are a few methods we’ve employed that have helped clients stay within their risk profile while limiting the tax hit on sales:
· Sell shares on a continual basis, especially if expecting to receive more shares as part of compensation. (Some companies offer 10b5-1 plans for insider sales).
· Employ active tax-loss harvesting. Separately Managed Accounts, in particular, can create a mechanism to maximize after-tax returns. (These can be more effective when implemented at the beginning of a tax year).
· Continually diversify to a pre-set portfolio mix. Use risk-analysis to figure out a portfolio mix that matches your risk-temperament, and keep gearing your portfolio that way.
· If there is an extremely sizeable position in a single stock, consider using an Exchange Fund for immediate diversification without a current tax-obligation.
As with many other aspects of your life, this should not be something that just falls to the wayside. You should consult with a CPA and your investment advisor to figure out a sound path for your individual situation.Work with the right people, plan, and take action.
Where do we go from here? This is part of a monthly blog series where I’ll be sharing insights and education from actual experience in working with clients. This blog is designed to reduce the complexity of managing your finances and provide transparency into how I work with you, my valued clients. I look forward to connecting with you here. Feel free to email me with your questions or comments at email@example.com.