Managing your Company Stock is a complicated matter. Not really from a pure finance and math perspective, in that case it is simple: sell it and invest the proceeds in a diversified portfolio. But, it can be complicated from an emotional perspective.

It is important to respect both: The Finance and The Emotion.

Before discussing some approaches to navigating the finance and emotions of owning Company Stock, let's discuss the most important action to take in regards to owning company stock.

Being Intentional

If you takeaway just one thing, it is this: Be intentional on how you manage your Company Stock. Avoid accumulating a large oversized position simply because it is the currency of your restricted stock, performance share units and/or stock options.

It is important to view your equity compensation the same as cash income. If you earn $100,000 in equity compensation ask yourself, "If I received $100,000 in cash what would I do with it?"

If the answer is buy more Company Stock, then you should leave that $100,000 in equity. If the answer is anything else - such as invest in an S&P 500 fund, pay down your mortgage, save for kids' college, take a vacation, or buy a boat - then consider selling.

Now, before we discuss the 3 reasons corporate executives own too much stock, let's quickly talk about the Right Kind of Risk and how it relates to managing a large equity position in a single company.

The Right Kind of Risk

There are infinite risks out there (reassuring, I know.) Some are known, others are unknown. Some are likely to happen, others unlikely. Some are just an inconvenience while others are disastrous. But let's look at two types of risk in your investment portfolio and how these risks impact the decision to hold Company Stock.

Single Company Risk explains how a single stock performs in isolation of the market. In other words, the risk that is unexplained by overall stock market performance. These risks include poor management decisions, losing market share to a competitor, fraud, legal issues, and black swan events. A diversified portfolio holding hundreds of stocks has minimal Company Risk - if a few companies go bankrupt, so what?

Market Risk explains how an investment(s) is impacted by external factors such as interest rates, consumer health, changing market trends, and general market sentiment. Since Market Risk impacts all stocks – albeit in various ways – investors are unable to eliminate it through diversification. As a result, investors receive a higher amount of expected return in exchange for adding market risk (aka Beta) while investors receive little, if any, additional return for adding Single Company Risk. This makes Market Risk, the Right Kind of Risk.

The extra risk of "holding all your eggs in one basket" is well known, especially by business executives. So, why is it common for corporate executives to hold oversized positions in Company Stock?

Here are 3 common reasons and some action items to help reduce oversized single stock positions in a thoughtful way.

1: It's Emotional...

Reason: I’ll start by saying that it is not necessary to sell all your company shares. It is fine to keep a decent sized position, but maintain it at a reasonable level relative to your overall wealth.

No, this is not the optimal course of action or what the finance textbooks recommend, but that is okay. If the goal is to minimize Risk AND Regret let's hedge the bet. That way if the stock shoots to the moon after the next earnings, you still participate. If it craters, then it is not that big of a deal.

Action: If you have a large position in a single stock, create a plan yourself or work with an advisor to decrease the position over time. Remember as a corporate executive you will need to account for minimum holding requirements, open trading windows and, possibly, filing a 10b5-1 with the SEC via your human resources department.

2: The Waiting Place

Yes, that is a reference to the best Dr. Seuss book, Oh, The Places You'll Go.

Reason: It is common and understandable to anchor your stock price expectations to a value recently achieved. Professional investors do it all the time. If the share price was $160 per share last month and now it is $140, let’s just wait for it to return to $160 and then sell. This is dangerous thinking because you may be waiting a long time for the stock price to return to a previous level. Yes, previous performance is not indicative of future performance.

Action: Similar to above, create a plan to decrease your single stock exposure, but do not sell it all. In the case that the stock shoots to the moon, you do not want the regret of selling at the "wrong" time.

10b5-1: If you are confident the price will rise, you can submit a 10b5-1 which allows you to sell the Company Stock at your price target even during the No Trading Windows.

3: Just Taxes

Reason: It is common for an executive to accumulate a significant amount of company shares over the course of their career via equity compensation. Since some of these shares were acquired several years prior, if not decades, the shares have likely accumulated a significant amount of taxable capital gains.

Actions:

Offset with Losses - Offset the capital gains on company stock with losses from other investment positions.

Gifting to Charity - Gift highly appreciated shares to charity which essentially eliminates Uncle Sam from the transaction - the charity receives the full market value and you deduct the full amount on your tax return.

Pass to Heirs - At your passing the shares receive a step up in cost basis making any capital gains achieved during your lifetime tax free (with the exception of possible estate taxes.)

Takeaway

The key takeaway is to manage exposure to company stock in a thoughtful and reasonable way, but respect the feelings you have about owning Company Stock. Owning an oversized position is fine as long as it is reasonable and does not jeopardize your goals.

Sometimes being reasonable is better than forcing yourself to be completely rational.

Mark Chisenhall, CFA is the founder of Taurus Financial Planning, a wealth management firm specializing in helping high-earning corporate executives reduce taxes, optimize investments, and accelerate retirement. Check out other relevant posts that take a deeper dive into understanding tax topics such as income taxes and withholding, tax-advantaged accounts, and managing concentrated company stock positions. If you are interested in learning more about working with Taurus Financial Planning, you can schedule an introductory call here.

This publication is for informational purposes only and is not intended as tax, accounting or legal advice or as an offer or solicitation of an offer to buy or sell or as an endorsement of any company security fund or other securities or non securities offering. This publication should not be relied upon as the sole factor in an investment making decision. Past performance is no indication of future results. Investment in securities involves significant risk and has the potential for partial or complete loss of funds invested. It should not be assumed that any recommendations made by the Author, in the future, will be profitable or equal the performance noted in this publication.