What to do with company stock plan?

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Trying2Save
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What to do with company stock plan?

Postby Trying2Save » Mon Jul 17, 2017 9:00 am

I was reading through some other threads that also discussed this topic but I wanted to get some of your opinions on this particular scenario.

My friend recently started a new job where they're allowed to contribute up to 20% of their salary towards their company stock program. The program discounts the stock 10%. The stock dividend is around 3.5%.

There are a few things my friend can potentially do:
1) Buy and sell the stock immediately to guarantee essentially a 2% additional income annually (maximum).
2) Buy and hold the stock collecting the 3.5% dividend and accept the fluctuation in stock price as the risk premium.
3) Buy and hold for one year so it converts to long term capital gains and sell only if the stock is up.

Some more information about the company. This is a utility company located in a dense metropolitan area therefore job security is fairly high. The company has a good track record with maintaining this 3.5% dividend.

Questions:
1) Which scenario do you think is best?
2) What are the tax implications of option 1? Is there anything else besides short term capital gains?
3) Is there anything you recommend besides the two options I listed above?

alex_686
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Re: What to do with company stock plan?

Postby alex_686 » Mon Jul 17, 2017 9:09 am

First, we can't tell which one would be best. Have your friend determine his goals and risk tolerance. This will inform him of his correct asset allocation and the amount of risk he can take. Then we can answer his questions.

That being said:

Option #1 is the lowest risk. Gains will be taxed as ordinary.

Option #2 does not make any rational sense. You should not care about dividend income. What one cares about is your portfolio's expected return and risk. How does this fit into this plan? One would need a compelling investment thesis to hold a concentrated position which had a high correlation with one's human capital. I had a friend of a friend who's retirement savings was in a nice safe utility company. It was bought out by Enron.

Option #3 has slightly higher risk. Gains will be taxed as long term.

My gut would say #3 - I would stretch for the slightly higher return but I have the ability and willingness to take on that risk.

dcabler
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Re: What to do with company stock plan?

Postby dcabler » Mon Jul 17, 2017 9:14 am

alex_686 wrote:First, we can't tell which one would be best. Have your friend determine his goals and risk tolerance. This will inform him of his correct asset allocation and the amount of risk he can take. Then we can answer his questions.

That being said:

Option #1 is the lowest risk. Gains will be taxed as ordinary.

Option #2 does not make any rational sense. You should not care about dividend income. What one cares about is your portfolio's expected return and risk. How does this fit into this plan? One would need a compelling investment thesis to hold a concentrated position which had a high correlation with one's human capital. I had a friend of a friend who's retirement savings was in a nice safe utility company. It was bought out by Enron.

Option #3 has slightly higher risk. Gains will be taxed as long term.

My gut would say #3 - I would stretch for the slightly higher return but I have the ability and willingness to take on that risk.


I have always done #1. This is money that I was going to invest in my taxable account according to my AA anyway, so why not have it pre-loaded with returns first? "Free money, low risk money".

CppCoder
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Re: What to do with company stock plan?

Postby CppCoder » Mon Jul 17, 2017 9:17 am

I would go with Option 1. That's the only one that is "free" money. Does your friend's IPS otherwise call for using 20% of his salary annually to buy his employer's stock? Take the 2% bonus and buy according to the IPS's AA.

Trying2Save
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Re: What to do with company stock plan?

Postby Trying2Save » Mon Jul 17, 2017 9:34 am

alex_686 wrote:First, we can't tell which one would be best. Have your friend determine his goals and risk tolerance. This will inform him of his correct asset allocation and the amount of risk he can take. Then we can answer his questions.

That being said:

Option #1 is the lowest risk. Gains will be taxed as ordinary.

Option #2 does not make any rational sense. You should not care about dividend income. What one cares about is your portfolio's expected return and risk. How does this fit into this plan? One would need a compelling investment thesis to hold a concentrated position which had a high correlation with one's human capital. I had a friend of a friend who's retirement savings was in a nice safe utility company. It was bought out by Enron.

Option #3 has slightly higher risk. Gains will be taxed as long term.

My gut would say #3 - I would stretch for the slightly higher return but I have the ability and willingness to take on that risk.


The thought process behind option 2 was that if you went with option 1 you would get a maximum of 2% additional income a year whereas option 2 is paying a higher dividend than you would get if you just bought and sold. Therefore, you'd be getting an additional 1.5%. Is this not how it works? I was using the dividend income to justify holding it longer rather than selling immediately. For example, if the dividend yield was only 1% I would advise my friend to sell the stock immediately because the long term risk is not worth it (having all your eggs in one basket).

Trying2Save
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Re: What to do with company stock plan?

Postby Trying2Save » Mon Jul 17, 2017 9:37 am

CppCoder wrote:I would go with Option 1. That's the only one that is "free" money. Does your friend's IPS otherwise call for using 20% of his salary annually to buy his employer's stock? Take the 2% bonus and buy according to the IPS's AA.


My friend does not really take interest in investing and generally follows the advice that I give him. If he sold the stock immediately, I do not think he would invest the money in a taxable account. He has opened an IRA but has already maxed out the contributions.

Jack FFR1846
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Re: What to do with company stock plan?

Postby Jack FFR1846 » Mon Jul 17, 2017 9:44 am

Analogy:

Your friend is handed free money. He can then (following your numbers):

#1) Put the money in his pocket and keep it.

#2) Bet it on black.

#3) Bet it on red.

This isn't rocket science in my opinion. Then again, I've seen company stock go from $48 (my buy price) to $12 in 6 months. I lost.
Bogle: Smart Beta is stupid

annielouise
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Re: What to do with company stock plan?

Postby annielouise » Mon Jul 17, 2017 9:48 am

The 10% discount is also taxed as ordinary income, right?

Our former company didn't include this in W2 income as stock was purchased or when it was sold (although I understand that most companies do). So when selling we had short/long term capital gains and had to add our 15% discount to line 7 (wages, salaries) of our 1040.

alex_686
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Re: What to do with company stock plan?

Postby alex_686 » Mon Jul 17, 2017 9:49 am

Trying2Save wrote:The thought process behind option 2 was that if you went with option 1 you would get a maximum of 2% additional income a year whereas option 2 is paying a higher dividend than you would get if you just bought and sold. Therefore, you'd be getting an additional 1.5%. Is this not how it works? I was using the dividend income to justify holding it longer rather than selling immediately. For example, if the dividend yield was only 1% I would advise my friend to sell the stock immediately because the long term risk is not worth it (having all your eggs in one basket).


I understand the argument you are making. It is seductive and wrong. You want to start at the top, focus on your goals.

Specifically, why do you think your utility company will outperform a equity index fund (S&P 500, Total Stock Market) on a risk adjusted basis? Can your friend tolerate the risk if the utility goes under, where he loses his savings and job simultaneously? It is a low probability event. More likely it will fall on hard times and will have to cut both payroll and dividends but it still should be considered.

Trying2Save
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Re: What to do with company stock plan?

Postby Trying2Save » Mon Jul 17, 2017 9:54 am

annielouise wrote:The 10% discount is also taxed as ordinary income, right?

Our former company didn't include this in W2 income as stock was purchased or when it was sold (although I understand that most companies do). So when selling we had short/long term capital gains and had to add our 15% discount to line 7 (wages, salaries) of our 1040.


I'm not entirely sure of the tax consequences surrounding the whole scenario. So if the discount is taxed as ordinary income, does it negate the benefit of buying/selling immediately?

CppCoder
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Re: What to do with company stock plan?

Postby CppCoder » Mon Jul 17, 2017 10:26 am

Trying2Save wrote:My friend does not really take interest in investing and generally follows the advice that I give him. If he sold the stock immediately, I do not think he would invest the money in a taxable account. He has opened an IRA but has already maxed out the contributions.

In that case, I think it is doubly important to take the extra 2% and not invest in things he doesn't understand. Worst case scenario, he can put the money in a 5 year CD and get 2.25% guaranteed per year. I'd take that position over a 3.5% dividend position in a single stock. That said, if your friend listens to your advice, maybe you should explain the benefits of investment diversification and opening a taxable account.

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tennisplyr
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Re: What to do with company stock plan?

Postby tennisplyr » Mon Jul 17, 2017 10:35 am

Personally, this happened to me. I just held the stock (as found money) and cashed out when I needed it. I know this isn't very scientific but that's me. I've funded several vacations like this.
Those who move forward with a happy spirit will find that things always work out.

annielouise
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Re: What to do with company stock plan?

Postby annielouise » Mon Jul 17, 2017 10:59 am

Trying2Save wrote:
annielouise wrote:The 10% discount is also taxed as ordinary income, right?

Our former company didn't include this in W2 income as stock was purchased or when it was sold (although I understand that most companies do). So when selling we had short/long term capital gains and had to add our 15% discount to line 7 (wages, salaries) of our 1040.


I'm not entirely sure of the tax consequences surrounding the whole scenario. So if the discount is taxed as ordinary income, does it negate the benefit of buying/selling immediately?


It slightly reduces the gain, but we still took advantage of it. At first we held and sold when we needed money for something and the sell would give us a gain, but then we switched to selling immediately. Personally, I would do the immediate sell unless it was a small amount of money and I had very good feelings about the company's future.

For example, right now we have a matching stock plan (2:1 match). We only invest $100 per month and have been letting it ride since it is just a tiny portion of our investments.

alex_686
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Re: What to do with company stock plan?

Postby alex_686 » Mon Jul 17, 2017 11:04 am

tennisplyr wrote:Personally, this happened to me. I just held the stock (as found money) and cashed out when I needed it. I know this isn't very scientific but that's me. I've funded several vacations like this.


There is no rational argument to do this. Rationally the most logical choice would be to sell the stock and buy a index fund. However it might address behavioral issues. Some people find it hard to save and this type of enforced savings - have it taken out of one's paycheck and then forget about it - could help these type of people. Investing money in a sub-optimal way is better than not investing at all.

123
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Re: What to do with company stock plan?

Postby 123 » Mon Jul 17, 2017 12:10 pm

Trying2Save wrote:...
1) Buy and sell the stock immediately to guarantee essentially a 2% additional income annually (maximum).


The chances of this being a workable option might be slim. Sometimes these stock purchase plans use an average price over a single day or over a number of days/weeks to price the stock and apply the discount. It may be some time after the purchase price is determined that the employee finds out what it was. While it's possible that everything is up-to-date and online immediately that might not be the case. Since the companies want to discourage people from profiting from the discount they may also make it inconvenient to get rid of it, you may have to even call the custodian to execute a sale and, quite possibly, there might be a fee/commission to sell. Companies do things that ultimately benefit them and not the employee.
The closest helping hand is at the end of your own arm.

Trying2Save
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Re: What to do with company stock plan?

Postby Trying2Save » Mon Jul 17, 2017 12:24 pm

123 wrote:
Trying2Save wrote:...
1) Buy and sell the stock immediately to guarantee essentially a 2% additional income annually (maximum).


The chances of this being a workable option might be slim. Sometimes these stock purchase plans use an average price over a single day or over a number of days/weeks to price the stock and apply the discount. It may be some time after the purchase price is determined that the employee finds out what it was. While it's possible that everything is up-to-date and online immediately that might not be the case. Since the companies want to discourage people from profiting from the discount they may also make it inconvenient to get rid of it, you may have to even call the custodian to execute a sale and, quite possibly, there might be a fee/commission to sell. Companies do things that ultimately benefit them and not the employee.


That is a very good point. I will look into this more before advising my friend. Thank you for the insight!

Trying2Save
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Re: What to do with company stock plan?

Postby Trying2Save » Mon Jul 17, 2017 12:25 pm

alex_686 wrote: Investing money in a sub-optimal way is better than not investing at all.


Couldn't agree more. Thank you for offering advice on my friends situation.

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djpeteski
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Re: What to do with company stock plan?

Postby djpeteski » Mon Jul 17, 2017 12:27 pm

alex_686 wrote:
My gut would say #3 - I would stretch for the slightly higher return but I have the ability and willingness to take on that risk.


I would agree with your analysis and shoot for this being no more than 10% of ones portfolio. If it is, they can sell those shares right away, and roll with a smaller amount. For this site, that 10% is probably way to high.


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