For many corporate executives, managing the investment risk associated with extensive company stock holdings can be both their greatest wealth challenge and their single biggest retirement risk. According to a recent Schwab survey, more than three-quarters (76 percent) of executives who have received stock options, restricted stock awards, and/or participate in an employee stock purchase plan have never exercised stock options or sold shares that are part of their equity compensation.1
Occasionally there may be instances where company stock holdings are difficult to liquidate due to contractual restrictions. For the vast majority of executives, however, the reluctance to pare back concentrated company stock holdings is often the result of emotional and behavioral drivers rather than any sort of legal prohibitions.
Why does selling feel wrong?
Concentrated stock positions are often driven more by comfort and familiarity than by dispassionate rational thought. Senior executives generally possess a deep knowledge of their particular company as well as their industry as a whole. This can lead to an overly optimistic sense of safety about the long-term prospects for their company stock holdings. Similarly, because corporate leaders tend to be so deeply immersed in the long-range vision and strategy of their organization, many come to believe that the marketplace is drastically undervaluing their stock’s share price.
More practical reasons can also factor into decisions to hold onto company stock. Some executives may worry that selling shares will be perceived by senior management as a lack of faith in the company’s vision—an act of disloyalty. Others may be reluctant to pay the tax bill associated with a sale. They would rather stay put and avoid “unnecessary” taxes rather than hedge against a major downturn that might never occur.
Holding a concentrated stock position, however, doesn’t just mean taking on excessive investment risk. It can also have a significant negative impact on your liquidity and cash flow.
Managing an accumulating position
One of the most common questions asked by our corporate executive clients is whether or not they should divest some of their holdings. Our answer is always unequivocal. If company stock makes up more than 10 percent of your portfolio holdings and you are under no selling restrictions (an insider with limited trading windows, contractual stock ownership requirements, or a situation where there’s a lock-up prior to an IPO) then you should absolutely begin to divest.
It’s a relatively straightforward endeavor to set aside the proceeds from a certain number of shares to cover your tax bill, and then simply transfer the remaining proceeds into your brokerage account. Of course if you do have selling restrictions, your options will be fairly limited. If no selling restrictions exist, however, there are a variety of strategies (aside from an outright sale) which you and your SunTrust advisor may want to consider including:
A 10b5-1 Trading Plan: These staged sale plans establish a pre-determined trading schedule that specifies precisely how many shares of stock will be sold and when, and then executes those sales automatically, thus satisfying most regulatory requirements and mitigating any insider trading concerns.
Staggered Sales over Time: If taxes are a major concern, you may want to explore staggering the exercise of options and subsequent sale of stock over a period of years to help spread out the tax burden.
Writing Covered Calls: Covered call options can be used as part of a systematic selling strategy where you agree to part with certain shares based on market movements, while at the same time receiving premium payments while you wait. A covered call writer forgoes participation in any increase in the stock price above the call exercise price, and continues to bear the downside risk of stock ownership if the stock price decreases more than the premium received.
Equity Collars: Designed to protect a concentrated stock position from downside price risk at little to no cost, this hedging technique involves purchasing both protective put options while at the same time selling covered calls—essentially placing both a floor and a ceiling on the stock price.
Option strategies of this nature can be more complex, and costs incurred with multi-leg option strategies such as collars may be significant as they can involve multiple commission charges. A limitation of these contracts includes possible loss of opportunity to participate in gains if the stock appreciates above the cap exercise price (ceiling) and while the equity collar can hedge against a loss of value in the stock (floor), it may not prevent it.
If someone walked up today and gave you $600,000 in cash, would you turn around and use that money to purchase shares of your employer’s stock? Odds are, probably not. So why—if your employer grants you $1,000,000 in restricted stock, withholds 40 percent for taxes, and deposits the remaining shares worth $600,000 into your brokerage account—do you feel such a strong compulsion to hold onto those shares?
You may believe your inside knowledge, special insights and hands-on ability to shape your company’s future justify holding a concentrated stock position. Don’t lose sight of the fact, however, that more than half of all companies (over the course of their lifetimes as publicly traded stocks) haven’t even outperformed cash.2
Holding the lion’s share of your assets in a single company—no matter how well you think you understand it—is a risky endeavor. Holding most of your wealth in the same company where your income is derived from not only exposes you to even greater risk, it’s contrary to our fundamental belief that a diversified portfolio is one of the best strategies to support the growth and preservation of your wealth over time.
Don’t put off a decision that’s so vital to your long-term financial health. Talk to your SunTrust advisor about any concentrated stock positions and together formulate a strategy to help mitigate that risk.