How do Bogleheads view "lottery tickets" (illiquid equity)?

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How do Bogleheads view "lottery tickets" (illiquid equity)?

Postby Ancal » Tue Jan 29, 2013 7:22 pm

Hi Bogleheads! First thread I've started. Hope it's not too stupid. :)

I work for a tech company that offers stock options as part of its compensation. These options are completely illiquid until a "liquidity event" (eg an IPO), and even then, they may have zero value (eg if the market share price is below the option strike price). So there is a possibility that the options are worth zilch.

However, there is also the possibility that the options have real value—up to several years' salary.

I'm curious as to how Bogleheads go about taking the value of such "assets" into account when crafting an investment strategy. I can think of three paths:

1. Assume the options are worth zero. This is the most conservative strategy, but it ignores the probability that the options will be worth SOMETHING and therefore pushes one to live a less comfortable lifestyle. It also might push one to take an equivalent job with a higher salary and no equity, which doesn't always make sense.

2. Assume the options will be worth a large amount of money. This seems foolhardy, but it would have implications for current asset allocation and saving rate.

3. Treat the options as a highly risky asset. This seems like a reasonable option, but it would have the net effect of making the rest of my portfolio MORE conservative (as I would shift other assets to balance out the risk). And if the equity doesn't pan out, I'm stuck with an under-aggressive portfolio.

Any advice/thoughts gladly received!
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Re: How do Bogleheads view "lottery tickets" (illiquid equit

Postby jdilla1107 » Tue Jan 29, 2013 7:25 pm

In my opinion, most people at start-ups over value their options and the probability of their company being successful by a lot. My vote is to treat their worth as zero.

Unless you are some sort of founder, these are not an investment, they are a form of possible future compensation. You call it illiquid equity, but options aren't even equity. They are an agreement to acquire equity in the future. Say you have the option to buy 25,000 shares. That number is meaningless, because it is undecided as to how many shares there will be in the future. A new VC could come in and immediately dilute the significance of that number by 100x. (I have seen this.)
Last edited by jdilla1107 on Tue Jan 29, 2013 7:32 pm, edited 2 times in total.
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Re: How do Bogleheads view "lottery tickets" (illiquid equit

Postby KyleAAA » Tue Jan 29, 2013 7:31 pm

I would tend to agree: their worth is almost zero. Only a very, very, very tiny minority of options end up being worth big bucks. A big number times a probability of close to zero equals an expectation of close to zero. The probability they'll be worth something probably isn't large enough to bother with. I'd just treat it as an unexpected windfall if I got lucky. I've had options at two different start-ups so far. Batting 0 for 2.
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Re: How do Bogleheads view "lottery tickets" (illiquid equit

Postby Rebecca_S » Tue Jan 29, 2013 7:57 pm

I valued mine, from 2 different companies, at zero.
One company, bought eventually by another and my stake now would buy a pizza or two after trading costs.
Another company, not public after 8-9 years but not quite dead (yet).
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Re: How do Bogleheads view "lottery tickets" (illiquid equit

Postby grok87 » Tue Jan 29, 2013 8:24 pm

Ancal wrote:Hi Bogleheads! First thread I've started. Hope it's not too stupid. :)

I work for a tech company that offers stock options as part of its compensation. These options are completely illiquid until a "liquidity event" (eg an IPO), and even then, they may have zero value (eg if the market share price is below the option strike price). So there is a possibility that the options are worth zilch.

However, there is also the possibility that the options have real value—up to several years' salary.

I'm curious as to how Bogleheads go about taking the value of such "assets" into account when crafting an investment strategy. I can think of three paths:

1. Assume the options are worth zero. This is the most conservative strategy, but it ignores the probability that the options will be worth SOMETHING and therefore pushes one to live a less comfortable lifestyle. It also might push one to take an equivalent job with a higher salary and no equity, which doesn't always make sense.

2. Assume the options will be worth a large amount of money. This seems foolhardy, but it would have implications for current asset allocation and saving rate.

3. Treat the options as a highly risky asset. This seems like a reasonable option, but it would have the net effect of making the rest of my portfolio MORE conservative (as I would shift other assets to balance out the risk). And if the equity doesn't pan out, I'm stuck with an under-aggressive portfolio.

Any advice/thoughts gladly received!

This isn't entirely logical, but i would ignore them for purposes of your investment portfolio. But if evaluating a job change, i would try to put a value on them.
cheers,
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Re: How do Bogleheads view "lottery tickets" (illiquid equit

Postby Ancal » Tue Jan 29, 2013 8:29 pm

Thank you for the thoughtful responses!

I suppose it's grok87's point that is holding me up on this. If the options should be value at zero for investment purposes, why should they have a positive value when considering whether it's worth taking (or holding on to) a job? That thinking seems emotional rather than rational. Or am I missing something?
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Re: How do Bogleheads view "lottery tickets" (illiquid equit

Postby LadyGeek » Tue Jan 29, 2013 9:03 pm

Ancal wrote:Hi Bogleheads! First thread I've started. Hope it's not too stupid. :)

Welcome! There's no such thing as a dumb question. If you don't know the answer, it's hard.

Your thread is now in the Investing - Theory, News & General, as it's more of a general investing question - no big deal in either case.

BTW, grok87 gives good advice. :wink:
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Re: How do Bogleheads view "lottery tickets" (illiquid equit

Postby neatep » Tue Jan 29, 2013 9:28 pm

I am a little confused by this part.
and even then, they may have zero value (eg if the market share price is below the option strike price). So there is a possibility that the options are worth zilch.


I would have presumed for a company that is not floated, that is issuing shares as part of a compensation package, that you would be getting a percentage of a company (which may or may not then be worth anything in the future). Which would mean that it has some value. (i would still value it is Zero in net worth calculations). I am not sure why they would be issuing strike prices for these shares (you would then have to evaluate how realistic this valuation would be). Its almost like having 2 layers of potential zero value, which seems crazy as a form of compensation.

Have people in this situation found this to be normal practice?

I presumed issuing strike prices was only for floated companies, where a value is easily obtainable and measurable.

Just curious.
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Re: How do Bogleheads view "lottery tickets" (illiquid equit

Postby nisiprius » Tue Jan 29, 2013 9:33 pm

My vote is for zero. That's what the stock options I had at two companies I worked for turned out to be worth. Fortunately it wasn't a lot and I wasn't mentally figuring it in--not counting it as compensation at all.

The stock I purchased through an employee stock purchase program, for 15% below market price, at a Fortune 500 company I once worked for, also turned out to be basically worth zero, but fortunately I hadn't put much money into it. I sunk a grand total of maybe $300 into it, and at the end I sold the stock certificate to a scripophily company for $9.95 which was about twice what it was worth as stock.
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Re: How do Bogleheads view "lottery tickets" (illiquid equit

Postby bottlecap » Tue Jan 29, 2013 9:45 pm

The title of the thread answers the question. If you buy a bunch of lottery tickets, how would you value them until you found the results of the drawing?

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Re: How do Bogleheads view "lottery tickets" (illiquid equit

Postby jhd » Tue Jan 29, 2013 9:45 pm

I'm in tech and have made money via stock options, but I also vote zero. Unless you have stock options at a fairly late-stage private company (like Twitter), where you can place a current value on them, you probably have a pretty low chance at a pretty high payout. That shouldn't change your asset allocation. If 70 global stocks/30 bonds is the right portfolio for you with 0% chance at $500K, it's probably also the right portfolio for you with a 2% chance at $500K.

Another way to look at it: let's say you bet a friend that the Vikings would win the Super Bowl in 2016. If they do, you make $500K, and if they don't, you make $0. Would you change your long-term asset allocation after making this bet?
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Re: How do Bogleheads view "lottery tickets" (illiquid equit

Postby Ancal » Tue Jan 29, 2013 10:02 pm

neatep wrote:I would have presumed for a company that is not floated, that is issuing shares as part of a compensation package, that you would be getting a percentage of a company (which may or may not then be worth anything in the future). Which would mean that it has some value. (i would still value it is Zero in net worth calculations). I am not sure why they would be issuing strike prices for these shares (you would then have to evaluate how realistic this valuation would be). Its almost like having 2 layers of potential zero value, which seems crazy as a form of compensation.

Have people in this situation found this to be normal practice?

I presumed issuing strike prices was only for floated companies, where a value is easily obtainable and measurable.

Just curious.


Yep—strangely enough, this is normal practice. You don't get stock; you get call options with a strike price. If a company is doing well, the later you join, the higher the strike price. There are some companies (such as Google) that just offer stock flat out.

Thanks everyone for all the advice. I like the bet analogy...although I have to point out that with an expected outcome of roughly $15,000, that is one of the greatest bets of all time and I'd take it any day.
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Re: How do Bogleheads view "lottery tickets" (illiquid equit

Postby grok87 » Tue Jan 29, 2013 10:28 pm

jhd wrote:I'm in tech and have made money via stock options, but I also vote zero. Unless you have stock options at a fairly late-stage private company (like Twitter), where you can place a current value on them, you probably have a pretty low chance at a pretty high payout. That shouldn't change your asset allocation. If 70 global stocks/30 bonds is the right portfolio for you with 0% chance at $500K, it's probably also the right portfolio for you with a 2% chance at $500K.

Another way to look at it: let's say you bet a friend that the Vikings would win the Super Bowl in 2016. If they do, you make $500K, and if they don't, you make $0. Would you change your long-term asset allocation after making this bet?

great explanation.
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Re: How do Bogleheads view "lottery tickets" (illiquid equit

Postby john94549 » Tue Jan 29, 2013 10:28 pm

Back in the go-go years of internet start-ups, my wife was granted 50,000 shares, vested, with what seemed like a reasonable strike. Two years later, "poof". But dreams are fun.
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Re: How do Bogleheads view "lottery tickets" (illiquid equit

Postby KyleAAA » Wed Jan 30, 2013 12:20 am

Ancal wrote:Thanks everyone for all the advice. I like the bet analogy...although I have to point out that with an expected outcome of roughly $15,000, that is one of the greatest bets of all time and I'd take it any day.


You have a relatively unrealistic opinion of the Vikings' chances, I think ;)
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Re: How do Bogleheads view "lottery tickets" (illiquid equit

Postby epilnk » Wed Jan 30, 2013 4:42 am

Before the IPO, zero. After the IPO, zero until liquidated even though they had actual, albeit changing, value. The IPO didn't make us rich but we have nothing to complain about; we sold most before they dropped to the current value. Obviously we're conservative.
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Re: How do Bogleheads view "lottery tickets" (illiquid equit

Postby Grt2bOutdoors » Wed Jan 30, 2013 9:39 am

A lottery ticket be it an actual lottery ticket or private equity start-up financing - is a "shot in the dark" or a "leap of faith" - you don't know if it will be successful. If you want to assign some value to it, let it be the lowest nominal amount of all your assets that way if nothing comes of it, you will not feel regret.
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