Wednesday, September 18, 2013

When Doubling Down Isn't Worth It

Many employees are given the opportunity to purchase company stock, via a discounted purchase plan, in an RRSP, with a company match, or stock options. This can be a small or large portion of the employees' total compensation, and, particularly in the case of stock options, encourage an employee to stay with the company. So what are the downsides?

The largest risk is lack of diversification, essentially that your employment and your investment are in the same place. If your company suffers difficulty, your employment and your investment are in jeopardy. Also, many employees, "drink the kool-aid" and overestimate the potential of their company compared to others in the industry. They don't pay the same critical eye as they would to other investments.

So what to do? In my case, I can purchase 10% of my salary in stock at a discount. So I purchase the stock at the discount, and then immediately unload the shares to gain the discount. I reinvest the proceeds in other investments.

Which brings to me to the next point, you need to carefully evaluate the terms, conditions and tax implications of accepting the advantage stock. In my case, the only disadvantage is that the discount is taxed as income, not as a capital gain. If you take stock options, there will be vesting requirements, that will tie you to the company. At executive and director levels, there can be mandatory share ownership requirements, to force the executive to have skin in the game with the company. Although, these levels are usually compensated well enough to manage the risk in other ways.

At the end of the day, you need to carefully consider the gains available from taking company stock, evaluating the terms, and any tax implications, and avoid putting too many eggs in the company basket. Look for opportunities to take the gains, but then sell the stock and place the profits elsewhere to avoid taking too much risk in one place.

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