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I'm just finishing up paying off my student loans (woohoo!) and am starting to look at places I can put my money to make it work for me. I've read Kobliner's Get a Financial Life and am interested in starting with ETF's, but I have a slight dilemma.

I work for a medium-sized company that is publicly traded on the NYSE1. They offer a program where I can allocate up to 15% of my paycheck (after tax) to buy their stock at 85% of the price. The only stipulation being that I have to hold it for 180 days (~6 months).

To me this seems like free money. The second that stock is bought, I've already made 100/85 => 17.6% on my money!

I'm very tempted to allocate the full 15% of my paychecks to this, but I know that it's important to diversify my investments.

I was planning to use 20% of each paycheck to play with for investments--would 15% company stock/5% ETF be diversified enough? Should I drop to 10%/10% or lower? Is there some reason I'm missing to not go all in on this?

EDIT:

I don't think this is a duplicate. The marked duplicate is asking (very broadly) how often "is good" to invest in an ESPP. I know I'm already going to be investing every chance that I get. My concern is one of diversification, which the duplicate makes no mention of. I've made it clear that I'm comparing between ESPP and ETF, while the duplicate seems to simply ask "what are your experiences with ESPP?"

1. It's worth noting that this company's stock has done incredibly well in the last 10 years. While I'm not expecting it to keep the same growth it has, this company is definitely not going anywhere anytime soon. An investment with them would definitely be safe. I have the utmost confidence in this company.

scohe001
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  • Got it, I think the choice on the diversification depends on your risk aversion and your expectation in the evolution of your company's stock price compared to the other investment options you're considering. I think is the same underlying answer as for the other question I linked to (and the posted answers look similar to me). Let's see what the other folks think, no strong preference, just avoiding duplicate information. – Franck Dernoncourt Mar 07 '19 at 21:10
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    Past Performance is Not an Indicator of Future Results – Harper - Reinstate Monica Mar 07 '19 at 21:18
  • @Harper thanks for the informative link! Like I said, I'm not expecting the company to continue growing at the crazy rate it has been (or even at all), but I'm as certain as I can be that this won't be the next Blockbuster/Circuit City for the next 5-10 years at least. – scohe001 Mar 07 '19 at 21:27
  • One thing that might help us better evaluate this 'how much' question would be to let us know how much you intend to put toward investments? If you are only going to save 15% of ur paycheck, and 100% goes to company stock, that might be a lack of diversification. If you are saving 60-70% of your take home, 15% goes to company stock, 20% to 401k, 5% to an IRA, rest 35% to an after tax; then you have plenty of diversity to offset this one piece of your savings. – Shorlan Mar 07 '19 at 23:14
  • @Shorlan I mention in the question that I'm reserving 20% of my income for active investments. The other 80 is a mix of savings/retirement/spending/etc...I don't think that 80% is relevant to the question since I either won't see it until I'm 65, it'll be spent that month, or I'm stashing it. But I can give the breakdown if you think it'd help... – scohe001 Mar 07 '19 at 23:19
  • The 15% of your paycheck doesn't appear to be relevant to the calculation of 17.6%. It's just 1/0.85. Could you please change it? – Eric Duminil Mar 08 '19 at 08:43
  • One thing to find out is if there are blackout periods when company employees cannot trade the stock. If so, this makes them less liquid, meaning that you sometimes cannot benefit from stock prices. It is often recommended to sell stock as soon as you can to guarantee a profit (https://workablewealth.com/2018/03/21/participate-espp-plan/) but a blackout could affect that. – camden_kid Mar 08 '19 at 09:27
  • If it's after tax anyway, is there anything stopping you from making the investment yourself? Would that be worse for some reason? – Mast Mar 08 '19 at 11:39
  • @EricDuminil Ahh I was actually already simplifying that fraction to get the profit (100/85 -> 1 + 15/85), but I can see how so many 15's running around all over the place can be confusing. I'll fix that. Thanks! – scohe001 Mar 08 '19 at 12:48
  • @Mast that would be 17.6% worse :P when buying through the company, I get a 15% discount on the stock, which is really the only thing that makes this worth looking into at all. – scohe001 Mar 08 '19 at 12:50
  • Ah, naturally, there's 2 15% values in play here. 15% of the paycheck and 15% discount. – Mast Mar 08 '19 at 13:47
  • "The second that stock is bought, I've already made 100/85 => 17.6% on my money!" No, the second you buy the stock, you have an unrealized 17.6% gain on your money. Anything could happen to the stock price in the 6 months before you are allowed to actually realize the gain by selling it. – chepner Mar 08 '19 at 14:00
  • OP is probably too young to remember Enron and WorldCom. – shoover Mar 08 '19 at 20:45
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    I owned Enron back in the day when it was in the 60's. I regularly sold covered calls on it because it offered good monthly premium. As dumb luck would have it, after the last rally before the beginning of its swan dive, I was assigned and had to sell my stock. It's often better to be lucky than to be smart :->) – Bob Baerker Mar 08 '19 at 22:10
  • I swear there used to be a question that would have been a duplicate. Something like "Employer added holding period to ESPP, still worth it?" I'm sure it existed at one point, because it was written by a coworker of mine. Maybe I'm just failing to find it. I know it was a different employer than OP's, because our plan had a 3 month offering period and a six month holding period. – stannius Mar 11 '19 at 15:08
  • Possible duplicate of Should I purchase company stock through my ESPP? – stannius Mar 11 '19 at 15:10
  • I found it. Not as popular and not as many answers. – stannius Mar 11 '19 at 15:11

5 Answers5

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It's not necessarily free money. If the stock declines by >15% in the six months after you buy it then you've lost money on the deal.

However assuming your company is performing at least reasonably compared to other stocks, you are, on average, getting a 15% bonus to your savings. You shouldn't be turning your nose up at that. (if whatever other stocks you invested in declined 15% after you invested you'd lose 15% instead of just breaking even).

There is a bit of a diversification factor in that not only would you be keeping your savings in one company, but its a company you work for. If it goes under, not only are you short some savings but you are also out of a job.

However the diversification problem is short term. You only have to keep the shares for 6 months, and you can sell them after that.

Let's say you are earning $50,000 and can afford to put $10,000 (20%) into savings. The first six months you put $7500 into your company, $2500 elsewhere. You are pretty vulnerable for that six months, but it's only six months.

In the second six months you again put $7500 into your company, but you also sell the original $7500. Now you have $7500 in your company but $12500 elsewhere. That makes you much less vulnerable. After a few years you are pretty diversified, and you've taken full advantage of the 15% bonus.

EDIT: I'm not recommending selling as soon as you can as necessarily the best strategy. Lots of factors would affect that. I'm setting out this scenario to illustrate how to maximize your diversification.

DJClayworth
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    You make a good point that if I continuously cycle through the company stock I can drastically lower my risk and have healthy diversification after a few cycles. But you'd suggest dropping the stocks after the 6 month period and eating the short term capital gains tax instead of holding for a full year? – scohe001 Mar 07 '19 at 16:27
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    If it’s like other ESPP plans I’m familiar with, the discount is taxed as ordinary income regardless of how long you own the stock. If the stock price has gone up a lot in six months, resulting in a large capital gain, is it better to lock in that gain, or hold the stock for another six months to reduce taxes? It’s totally up to your risk tolerance. – prl Mar 07 '19 at 16:54
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    @prl Ahh I thought the discount was taxed like capital gains, not as income. In that case I think you're right. Unless there's been a large increase in stock value it's probably better to drop it at 6 months. – scohe001 Mar 07 '19 at 17:09
  • How much is capital gains and how much is income depends on how long you held it and whether it went up or down. It's called a qualifying disposition if you held it for at least two years after it was granted. For ESPP, that's the start date of the period, so in your case you'd have to hold them 18 months after purchase, 12 months after you could have sold them. It's not always advantageous to have the disposition be qualifying. Regardless of qualifying vs. disqualifying, the part that is capital gains is taxed at a rate based on whether you held them 12 months after purchase or not. – stannius Mar 07 '19 at 21:06
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    Anyways it's moot because I for sure would sell that stock the minute I could. It's just too risky in my opinion to hold on to employer stock hoping you can save a bit on taxes. – stannius Mar 07 '19 at 21:07
  • The problem is, if you do a sale within 12 months, that too is taxed as compensation. You need to hold the asset for awhile to qualify for the long term capital gains rate of 10% or 15%. – Harper - Reinstate Monica Mar 07 '19 at 21:20
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    @Harper If you have a good idea of what goes into the decision on when to sell, I think that would be worth an answer in itself. The last sentences of this answer leave a lot open. – JollyJoker Mar 08 '19 at 12:01
  • @stannius If you sell the stock before it's taxed as LTCG, the tax on the sale could wipe out that 15% discount. No more free money. – Barmar Mar 09 '19 at 22:27
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    @Barmar - Since taxation takes away a portion of the 15% as well as a portion of the capital gain (whether LT or ST), it cannot wipe out the 15% discount. – Bob Baerker Mar 11 '19 at 00:45
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This is probably above your pay grade but if your company's stock offers options, there are a number of hedging strategies that would protect you.

The simplest one would be to buy 6 month puts whose break even was less than 15% out-of-the-money. You'd be throwing away that premium but it would protect you against all loss of principal.

As a random example, consider a similar 15% opportunity today with IBM at $136.00. 15% lower is $115.60 and below that you'd lose money. Buying the Oct 120 put (7 months) for $3.75 gives you a break even price of $116.25, below which you are 100% protected. The worst case scenario is that you make 65 cents and the best case scenario is that the investment appreciates above $136.00, providing an additional profit beyond the above numbers ($20.40 - $3.75 + share price appreciation).

If IBM were to drop to near or below $120 before October, the put would also gain time value and the net position would be worth more than the break even values. I'll leave it at that since this is another rung up the option food chain.

If I had this 15% discount opportunity with savings on the side and I wanted to hedge, my preference would be a modest debit OTM long stock collar - potential to make 10% more to the upside (above and beyond the 15%) and the potential to lose only 10% of the 15% to the downside (yes, another rung up).

If your stock does not offer options and I've you believe that it's a fundamentally sound company, I'd still load up on it, to the maximum of 15% if you can manage it. The 15% is absolutely free money. You may lose it due to market conditions but that 15% is not your money being lost.

Investors in the market lost 20-25% last December. I think that every one of them would be thrilled to have been shielded from the first 15% of loss. You're young and losing 15% of your salary in 6 months is painful but not the end of the world (your company goes belly up).

When I first started investing 40+ years ago, I opened a number of DRIPs with companies that offered a 5% discount on dividends as well as a 5% discount on new money. It definitely helped with the early stage of my accumulation phase.

And FWIW, I employ some synthetic option strategies that offer a downside buffer of 15-20% with an upside cap of maybe 10%. Most of the time, this is captures a large part of the up moves and avoids most of the downdrafts.

Should you decide to follow this advice and you lose it all, I'll be changing my handle ;->)

Bob Baerker
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    First sentence reads as tactless/rude. What benefit is there to suggesting something is above someone else's pay grade. – Hart CO Mar 07 '19 at 17:58
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    Be sure to check your company's rules before buying put options; it's definitely prohibited at my company, presumably to avoid the appearance of insider trading. I bought put options to hedge against the industry instead. – Justin Mar 07 '19 at 18:34
  • Option hedging is a complex strategy with many subtle and esoteric nuances. It is not for the sensitive and uninformed. Checking company rules is a very good suggestion. If prohibited then one could hedge via another highly correlated stock and better yet, as you suggested, you have hedge the sector. Either way may be problematic if the correlation doesn't hold. – Bob Baerker Mar 07 '19 at 20:04
  • I bought some put options when my employer added a six month holding period. Shorting the stock was prohibited, but nothing about buying or selling options. None of my options ended up being worth anything more than peace of mind. But that's OK. – stannius Mar 07 '19 at 21:10
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    I like the answer, but it almost assuredly a violation of company policy to buy a put in the company you work for. – Harper - Reinstate Monica Mar 07 '19 at 21:22
  • @Harper: A well-considered policy would treat covered and naked puts separately. You wouldn't want employees invested in naked puts, for the same reason they shouldn't short the company. But a protective put is entirely different. – Ben Voigt Mar 11 '19 at 00:13
  • @Ben Voigt - "Investing in naked puts" is incorrect terminology. You are long when you buy them. Naked puts means selling them without a position in the underlying. A 'protective put' is long the underlying and long a put, usually with a strike near the underlying's current price. A 'covered put' is a short position in the underlying combined with a short put (not applicable to this discussion) and is the mirror image of a 'covered call'. The 4th risk graph in this grouping is a protective call which is short underlying and long a call (also not applicable here). – Bob Baerker Mar 11 '19 at 00:41
  • @BobBaerker: Thanks for your explanations of the meanings. Long and protective puts are exactly what I meant to discuss, my reference to covered puts was an error. You said "Naked puts means selling them without a position in the underlying" but that makes no sense -- selling a put allows someone to force you to buy the underlying, so whether you already have a position in it makes no difference whatsoever. – Ben Voigt Mar 11 '19 at 00:44
  • You're welcome. I was just trying to keep the herd running in the same direction :->) – Bob Baerker Mar 11 '19 at 00:48
  • Oh, I see that there are at least two different definitions for "naked put" -- or possibly three different categories of short put, and different people contrast naked against either of the other two. The three are: cash-secured short put, short-hedged short put, and naked short put. So a put's not naked if sold backed by sufficient cash to make the purchase if the option is exercised -- but that definitely is also not what I meant earlier. – Ben Voigt Mar 11 '19 at 00:52
  • Once upon a time, some old timers called buying puts being long naked puts (not combined with other positions).That terminology was fleeting and is not current. There is only one definition for 'naked put'. When combined with other option and.or underlying positions, they become other strategies. 'Naked put' is where you sell the put short with no other position in the underlying. Cash secured short put adds a 2nd ingredient (+$ - P). A 'covered put' is short stock + short put (-S -P) and is equivalent to selling a naked call. A 'protective call' is equivalent to buying a long put (-S + C). – Bob Baerker Mar 11 '19 at 01:07
  • See if the explanation of the Synthetic Triangle helps you make better sense of this: https://www.brainscape.com/flashcards/option-strategies-and-synthetic-positions-4804798/packs/1767253 – Bob Baerker Mar 11 '19 at 01:07
  • @Harper when I worked for a company that introduced a six month holding period, I looked closely at the employee handbook. Shorting the company was prohibited, but they forgot to prohibit options. So you never know. – stannius Mar 11 '19 at 15:27
  • @stannius i think they would look at it netted. – Harper - Reinstate Monica Mar 11 '19 at 20:05
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Think about Allocation

Ignore the discount for a moment. Ask yourself, "How much would I invest in my employer in a vacuum?"

50% of your portfolio? 5%?

There's some value that you are going to feel good about, based on your risk tolerance, and your evaluation of your employer. Give yourself a small bump for the 15% price discount, and target that number.

Example

Say, without the discount you would be comfortable putting 10% of your investments in your employer and 90% diversified.

Bump the 10% up to 12% to account for the price discount, and go. After a year or two, reevaluate. If you still feel good about the company, consider selling the vested stock and moving it to your ETF.

Now your ETF is almost 100% of your assests - you can up the allocation for your company stock above 12% to rebalance toward the distribution you wanted. Repeat every year or two.

codeMonkey
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  • Note that the answer to "How much would I invest?" is likely to differ depending on the time horizon. You might not want to tie up a large portion for a long time, but for 6 months it could be OK. – Barmar Mar 09 '19 at 22:33
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One perspective is to consider the ESPP purchase as having the same restrictions, but purchased on the open market (and not associated with your employer):

  1. The stock in this case would be a comparably-performing company in the same sector as the one you're working at (such as a competitor).
  2. You have to escrow funds over the next six months to buy it
  3. When you buy it, you get a 15% discount off a start/end-of-period price lock
  4. You have to hold it for 6 months after purchase

If it's a good purchase under those conditions, it probably makes sense for you as an investment. Item 3's condition may be sufficient reason to buy the stock of any stable company on the open market under these terms.

user117529
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  • Compared to these conditions, the deal offered to OP is worse, because it concentrates his investment risk and his employment risk together. – Ben Voigt Mar 11 '19 at 00:15
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It sounds like you and everyone else there have negotiating leverage.

Do not hesitate to discuss this with your manager and everyone else there, because they are asking the same questions.

read this thread: https://www.bogleheads.org/forum/viewtopic.php?t=185373

Are you really forced to "hold" the stock for 6 months?

Stocks can easily drop 15% for many reasons that have little to do with the companies performance:

  • lockup period expiring
  • a mild 10% stock market drop can easily cause a 30% drop in high risk equities

A good example would be SnapChat stock. Extremely successful app, but unfortunate if you bought it 12 months ago.

Keith Knauber
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