Welcome to the 9th edition of the Tech Financial Planning (TFP) Newsletter
So you have a big chunk of money in your company stock.
Through hard work, good fortune, and some solid equity awards, you’ve built up a nice nest egg.
You’ve done well for yourself, so why should you sell (hint - the Titanic was supposed to be unsinkable)?
In this newsletter we will go over the real risk of concentrated positions, how to think about holding one, and some thoughts on selling.
TL;DR
Concentration creates wealth, diversification preserves it
While things can seem ok right now, the real risk is what happens if your company stock tanked overnight.
However unlikely it may seem, it’s happened countless times throughout history
You don’t have to sell everything all at once
Concentration creates wealth
People made a lot of money the last 10 years through their equity compensation.
As I wrote before, “Jeff Bezos, Elon Musk, and Mark Zuckerberg would not be as wealthy as they are if they had sold all their company stock and diversified years ago.”
It’s great, and I’m no different.
My single greatest investment has been my Procore stock, because I was granted a bunch of options at $2 and $10.
Even with the volatility this year, my shares at $2 have gone up 25X!
So if your company stock has done so well, why would you ever want to sell?
The real risk
What would happen if your company stock tanked overnight?
No matter how you think about your company stock, what would be the effect on you and your family if it DID crash?
This is THE single question we must assess
Another way of thinking about it - let's look at your financial plan as if your concentrated position didn’t exist.
If the result makes you gasp, you need to start trimming your position.
But my company’s roadmap…
Most people are enthusiastic about their company, and that’s a good thing.
They are excited about who they work for, the problems they're solving, and the company’s roadmap.
Good times ahead!
The problem is history is chocked full of examples of promising companies going south.
Consider the following:
As of 2019 there were only 52 companies in the Fortune 500 that had been there in 1955 and remained on that list the entire time.
The rest–the other 90%-went bankrupt, merged, were acquired, or shrank so much that they fell off the list.
Put simply, most companies fall by the wayside.
Let’s look at some specifics.
Cisco Systems was THE hot stock of internet mania.
In 1998, they traded at $10/ share.
Fueled by the dot com boom, it hit $82 in March of 2020, becoming the must-own stock of it’s time.
By September 2002, it was back to $10, and as of writing, it trades at $40.
And it’s never touched $80 - the closest it got was a touch above $60 in 2021.
Even more drastic is Bear Stearns.
As Nick Murray writes, “Bear Stearns never had a losing year in the 85 years from its founding in 1923 until it vaporized in a matter of days in 2008.”
They reported their first loss in Dec 2007, and less than 3 months later they were bought by JP Morgan Chase.
They crushed it for 80 years, and in 3 months they were gone.
Moral of the story:
If you're going to have a bunch of money in one company, you have to be ok with the risk that it can disappear at the snap of a finger.
Shoutout all the Marvel fans who get this bad joke.
It’s the story of the Titanic all over again.
The Titanic had 16 watertight compartments, and would have been okay if up to four of them flooded.
For all practical purposes, she was considered “unsinkable.”
She was the highest quality ocean liner ever created.
But when the Titanic hit the iceberg, water flooded six compartments.
The rest is history - although it still doesn’t explain why Rose didn’t let Jack on the door.
These are typically unforeseen events.
The Titanic hitting an iceberg and flooding 6 compartments.
Few people foresaw the impact of all the subprime mortgages
Covid came out of seemingly nowhere.
The fraud and corruption at Enron caught most people by surprise.
So while your company seems to be in a good place, what could cause it to fail overnight?
An unforeseen competitor
Fraud and corruption you didn’t know about
New laws and regulations
Macroeconomic circumstances
Losing key leadership (can you imagine what would happen to Tesla if something happened to Elon?)
However unlikely, IF this were to happen, would it affect your financial plan?
If yes, it makes sense to sell some.
Some Thoughts On Selling
You don’t have to liquidate your entire position
You’ll see rules of thumb that say you should target 10-20%, but again, those are just rules of thumb.
The real answer is how much risk can you afford?
If your concentrated position disappeared overnight, would you still be ok?
If you have room for error, you can take more risk.
“So if your company stock dropped 50% tomorrow, you’d still be ok. It doesn’t do anything to your current financial situation.”
If you sell, and the stock starts taking off, you didn’t make a bad decision
You weren’t making a judgment about your company or the value of the stock.
You were lowering your amount of risk, and because of that, you made the right decision.
I made this exact mistake because I didn't have a plan for my Procore stock.
Procore went public over a year ago, but as a former employee, I was subject to the post-IPO lockout, which means I couldn't sell any shares for 6 months.
Once the 6 months were up, I didn't have any plans to sell.
I didn't need the cash, so I figured I might as well wait for "some arbitrary point in the future."
Since then, Procore stock fell 50% and currently trades around $50.
It's really easy to look back and say that I should have sold.
So let's take the other side and ask, what if Procore stock had doubled?
I still made the wrong decision because I didn't have a plan.
For my family, that was too much risk.
"I'll sell it when it's higher" isn't a plan.
Now?
I've started diversifying my shares.
I still hold some, but Procore was making up too much of my portfolio for my goals.
Yes, I sold when the stock was down.
But I don't have to make back the money I lost in the same stock I lost it in.
Investment Loss > Taxes
Some people don’t want to sell because they don’t want to pay the taxes.
And capital gains are a very real issue.
But the potential loss can be significantly more than the capital gains tax.
Let’s look at an example.
You have $1M in company stock that has a basis of $100,000, which means you have a $900,000 gain.
If you were to sell it all at once, you would pay $324,792 in capital gains tax (our example is a CA resident and we are assuming long term capital gains).
Certainly no small bill.
But if the stock drops 70%, like many tech stocks have this year, you just lost $700,000.
A lot more than paying the tax.
This is often referred to as not letting the tax tail wag the dog.
Taxes are important, but they aren’t the only thing that matters.
Another way to diversify is to invest more
As long as it’s not your company stock.
Let’s say you have a million in company stock and a million in other investments.
Right now your company stock is 50% of your net worth.
If you invest an extra $250,000 into something else, now your company stock is 44% of your net worth.
Continue to do this over time and the percentage of your net worth will continue to decrease.
Putting it all together
Concentration is a great way to build wealth, but at some point it makes sense to diversify some (or all).
In nearly every case, the risk of having the majority of your net worth in your company stock is too great.
It’s not a value judgment on the future of the company or how successful it’s been in the past
It’s about protecting you and your family for the future and making sure you are on the right path.
Whenever you're ready, there are 3 ways I can help you:
1. Connect with me on LinkedIn, where I post every weekday (unless I’m on vacation). https://www.linkedin.com/in/marshalljoe/
2. Subscribe to the “Tech Financial Planning” newsletter to get equity comp and financial planning strategies in your inbox every Saturday. It’s free: TFP Newsletter
3. Want one on one help? Schedule a 25 minute “Are We A Fit?” meeting