By Kirsty Peev, CFP®
We recently received a request from the media to comment on what to do if you own company stock, yet want to create an overall diversified portfolio. This might seem like an oddly specific topic, but it is an instructive one. So many people have highly individual details in their financial lives (owning a business, having a varying income, etc.) that can be addressed by a holistic view of their overall financial picture—not missing the forest for the trees, so to speak! Even if you don’t own company stock, I hope this mini case study will give you a window into how I approach portfolio design decisions when it’s not a cut-and-dried situation.
A portion of the compensation package for executives sometimes comes in the form of company stock or stock options (the right to buy company stock at a fixed price). This can be a great way for companies to retain top employees, and for employees to show they are literally invested in their workplace, but it does not come without risk.
We caution clients about over-loading on company stock (to the degree they can control) because ‘doubling down’ on one company (e.g. your income AND your investment portfolio) means you could be hit in two areas of your financial life if the company suffers losses. We do not use individual stocks in our portfolio design because of that business risk, and the fact that it decreases diversification.
However, if you already have company stock it is not a terrible thing—just a consideration that must be taken into account when designing the rest of the portfolio. Here are a few protective steps I take when designing the portfolio for these scenarios.
Use overexposure to a certain area as an equivalence for the asset class. Say, for example, you work at GE, and you own a large amount of GE stock. This company’s stock is considered to be in the “large cap value” category, which we hold in varying proportions depending on the individual client’s needs. However, one company does not equate to a whole sector or industry—more diversification is needed to spread out that risk. I would try to take overexposure to a particular stock into an account as an ‘equivalence’ to the sector in designing the portfolio. With the GE example, I might allocate slightly less to large-cap value funds in the portfolio to avoid overexposure to the area while adding diversification.
Take taxes into account when selling company stock. Employer stock can be complicated, and there may be certain rules or restrictions on selling your shares. You want to make sure you don’t load up on short-term gains which are taxed as income, versus long-term gains which qualify for the more favorable long-term tax treatment.
Use protective trading strategies. I would recommend using protective trading strategies like a Trailing Stop Loss (TSL) order on the liquid part of your employer stock portfolio. Set this at a particular percentage (let’s say 5% for this example). As long as the price of the stock rises, stays stagnant, or does not fall by 5% from the high trading price going forward, you continue to hold your stock as-is. If the price drops by 5% from the highest price going forward, the TSL activates and your shares are sold. This is a great way to remain invested in a stock or ETF and participate in gains going forward, while limiting losses.
There is no cost for placing a TSL, unlike other hedging strategies like options trading. Most investors should not dabble in options trading as a hedge—it is very complicated, costly, and does not add significantly to portfolio returns for most people.
There are many ways to achieve the goals of proper asset allocation, diversification and tax efficiency in your portfolio—and we can work with you to determine a strategy for your individual situation. If you have an unusual situation like company stock options, we want to know! It helps us to create a holistic solution for your overall financial life.
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