277 | Should You Diversify Your Employer Stock? Here’s the Data… And a Plan

[00:00:00] Hilary Hendershott: Welcome to Love, your Money^®, the podcast that helps you grow, keep, and enjoy your wealth with confidence. I’m your host, Hilary Hendershott, and today we’re tackling a financial risk I see far too often, and that’s holding too much of your employer stock. If you work for a company currently being referred to as one of the Magnificent 7, responsible for a very outsized percentage of the performance of the S&P 500 over the recent past, and by recent past, I mean years–think Apple, Microsoft, Nvidia, Google, Amazon, Tesla, or Meta–this episode is for you. Many of you have built up a significant amount of employer stock through stock options, RSUs, or other equity compensation. And if you love your company and I love that for you, but when it comes to investing, emotions can cloud judgment.

[00:00:52] So, today we’re breaking down why diversification is the key to protecting and growing your wealth. We’ll discuss the risks of concentrated stock positions, why the biggest companies rarely stay on top forever, and how a globally diversified portfolio can help you minimize risk while maximizing risk-adjusted return. We’re also going to talk about how you can be smart, strategic, and tax-aware when it comes to managing your investments and growing your wealth. So, if you’ve been holding on to company stock, whether you’re with a Magnificent 7 or you’ve got a bunch of other company stock hoping it’ll keep climbing indefinitely, stick around. It’s time to get strategic with your wealth. Let’s dive in.

[00:01:34] Hilary Hendershott: First up, we are going to talk about the illusion of safety in employer stock. Let’s just start with a hard truth. Just because you work for a company doesn’t mean its stock is a safe bet for you. I see this all the time. Employees feel deeply connected to their company’s stock. You believe in the mission. You see the growth. And if the stock price has been climbing, it’s really easy to assume and hope and just engage optimism that that trend will continue. But history warns us about a very different version of that story. Think about Enron, Lehman Brothers, Walgreens, Intel. At one point, those stocks seemed unstoppable. But for employees who held on to too much of that company’s stock, the outcome was literally devastating. For some, their wealth vanished practically overnight.

[00:02:37] So, what’s the risk here? It is called concentration risk, and that’s when too much of your wealth is tied to a single investment. If your company’s stock takes a hit, you’re not just dealing with a dip in your portfolio. Stock prices fall for a reason, and they can be the harbinger of bad things to come with your company. One of those might be job cuts. You could lose your income and a huge portion of your net worth at the same time. And that’s why financial planners, myself included, are always kind of strongly recommending diversifying. Now, I get it. Over the past years, my team and I have seen more and more clients eager to hang on to large swaths of their company stock. The thought process is totally understandable. I get it. You think your company is different, that its stock has something special; something unique that makes it exempt from the usual market forces.

[00:03:42] But here’s a gentle reminder. Stock prices change only on new information. Everything you know and love about your company? It’s already baked into the price. And here’s what data from a Dimensional Fund Advisors study analyzing “the outperformance of companies before and after the first year they became one of the ten largest in the U.S. from 1927 through 2023” tells us: Once companies reach the top ten by market capitalization, their stock performance tends to slow down in the years that follow. It makes sense. Once something reaches the top, there’s not much room left to climb. Think of it like this. Once a thing reaches the top, there just isn’t much further to grow.

[00:04:30] Those who’ve summited Mount Everest will never reach a higher peak. Usain Bolt will never shave a minute off his mile time. The pitcher who throws a perfect game, one game, can’t throw an even more perfect game the next. And stocks that reach the top? They tend to see diminishing returns. Now, we know that over the past five years, the performance trend in the US large asset class to which these companies belong, the Magnificent 7, has been unusually strong, but there’s no evidence to support that the trend will continue unabated. In fact, it defies logic that it will. Your warm feelings towards your big company stock position are totally valid, and they’re based on the past 5 or 10 years.

[00:05:25] However, you want your investment decisions to have their eye on the future, not the past. History has shown us that economic downturns and market corrections often hit concentrated stock positions hard. Remember the dot-com bubble of 2000 when the NASDAQ fell 78% in less than two years? Or the 2008 financial crisis when the DOW lost 50% of its value and financial stocks, which had been the market darlings, dropped more than 90%? If your wealth is too heavily tied to one stock, a similar event could mean massive paper losses or worse. So, if the risks are so clear, why do people hold on to their employer stock anyway? Well, a big reason is emotional attachment. You’ve invested your time, energy, and maybe even part of your identity in this company. You’re proud to be an employee. Selling can feel like you’re betting against the home team or even betting against your own success.

[00:06:45] And what you don’t realize, though, is if your company’s stock price falls precipitously, none of those emotional loyalties will build your account balance back up. When it comes to financial freedom, your company’s stock may have gotten you here, but only you can get yourself there. Then there’s FOMO, the fear of missing out. You think, “What if the stock doubles next year? I don’t want to sell too early and leave money on the table.” But here’s the thing. You really don’t need to time the market perfectly to come out ahead. You just need to take calculated steps to protect what you’ve built. Here’s another powerful way to think about this. Let’s say you have $2 million in company stock today.

[00:07:29] Now, alternative scenario. What if I gave you $2 million in cash? A huge pot of money. Would you use every last cent of that $2 million to buy your own company stock? I doubt it. I’m really hoping your answer to that question was illuminating for you. And it shows you your own potential vulnerability to a cognitive bias called the Endowment Effect, where people irrationally value what they already own more than it’s actually worth. So, what’s the solution? That’s what we’ll cover next: why diversification is the key to long-term financial security and how you can start selling your employer stock strategically. Stay with me.

[00:08:12] Now we’re going to talk about creating a smart diversification plan. So, now that we’ve talked about the risks of holding too much employer stock, let’s focus on solutions. Because here’s the thing, diversification isn’t just a good idea, it’s essential for long-term financial success. I know what you might be thinking. “Okay. Hilary, I get it. But how do I actually go about selling my employer stock without making a tax mistake or missing out on potential gains?” So, here’s some good news. There are smart ways to do this. There are ways that protect your wealth, minimize taxes, and set you up for a more secure financial future. And that’s what we’re going to talk about next.

[00:08:51] But first, you have to understand your equity type. So, before you sell anything, you need to understand what kind of stock you actually own. What are its tax characteristics? Different types of equity have different tax implications and you don’t want to get caught off guard. So, let’s talk about stock options. Stock options are either incentive stock options, also called ISOs, or non-qualified stock options which are called NSOs. Both vesting and exercising them are taxable events. Make sure you understand the timing and the potential tax bill before making a move. Next are restricted stock units or RSUs. RSUs are typically taxed as ordinary income when they vest. If you continue to hold them and they grow in value, you’ll owe capital gains tax when you sell them.

[00:09:44] Next up, we have employee stock purchase plans or ESPPs. I often refer to this as the alphabet soup of Silicon Valley equity compensation, and that’s the whole of all these types of equity compensation. Some ESPPs offer favorable tax treatment if you hold the stock for a certain period, typically a year. If you sell before that year is up, you could owe higher taxes in the form of short-term capital gains taxes. It’s just a higher rate than long-term capital gains taxes. Next up, you have purchasing the stock outright. This is the “regular way” of owning a stock and it may not be tied to your employer. In this case, if you sell the shares at a gain, you will owe capital gains tax.

[00:10:27] Finally, you have employer stock in your 401(k). Withdrawals from your 401(k) are taxed as ordinary income. Assuming you’re over age 59.5, there is no penalty. If you’re under age 59.5, you pay ordinary income tax plus the penalty. There are also special provisions for what’s called net unrealized appreciation (acronym: NUA) of shares of employer stock that may be available to you when you leave your employer. The key takeaway here is not all stock is created equal. That’s why it’s so important that you work with a financial professional to develop a selling strategy that minimizes taxes.

[00:11:24] Step two, when it comes to selling your employer stock, now that you’ve identified your equity type, you’re going to develop a smart selling strategy. So, you’re ready to start selling. But what’s the best way to do it? There are a few options to consider. First, you can sell it all at once. Very viable strategy and it’s one I’ve often recommended. If you’re done hanging on to your company’s stock and you’re really done living with that kind of concentrated stock risk in your life, selling all at once is a perfectly viable strategy. I know the associated tax bill can hurt, but ultimately, selling your stock, and paying the tax that you need to do that, is the only way to unwind your concentrated position. If you’re already high income, you may expect to be in the top marginal tax brackets for years to come, so there’s really no savings to be had by waiting. You can just rip that Band-Aid off. We’ve helped many clients do it.

[00:12:22] Potential plan two is sell in stages. Rather than selling all at once, consider selling gradually over time. This approach reduces risk and helps you avoid making emotionally charged decisions based on short-term market swings. You could do something like sell 20% of it every year for five years or another percentage over another period of years. Selling over time to diversify is a standard approach with company stock. Bill Gates did it with Microsoft shares. Jeff Bezos did it and is probably still doing it with Amazon stock. And Larry and Sergey took the same approach at Google.

[00:12:58] Finally, you could use a 10b5-1 plan. For a lot of officers and directors of companies, this might be the best option to sell your shares to avoid insider trading accusations. This is a pre-scheduled stock-selling plan that allows you to sell shares at predetermined times. It’s a great way to remove emotions and the possibility of trading on material nonpublic information from the process and ensure you’re making rational, systematic financial decisions. Each of these strategies comes with its own set of tax implications, and that can’t be ignored.

[00:13:44] And the third and final step is, of course, pay the tax. Ideally, you’re liquidating your company’s stock with the assistance of your financial team, who can help you estimate the tax that you will owe. Side note: keep listening for a new-to-market strategy we’re offering to help you minimize the tax burden as you maximize gains. If it’s a large amount of money, you may want to make federal and state tax payments sooner versus later. You don’t want to be on the IRS’s dashboard. It’s best to work with your tax planner to determine how much you should pay at the time of sale to avoid underpayment penalties. The tax planner may recommend you pay just enough now to avoid the underpayment penalty, estimate what the full tax amount will be, and keep the rest in a high-yield savings account until the final tax bill is due.

[00:14:40] And finally, step four is invest in a diversified portfolio. Selling your employer stock is only half the equation. Now, you’ve got cash. What you do with the proceeds matters just as much. At Hendershott Wealth Management, we follow a wisdom-based, research-backed, diversified investment strategy designed to help you minimize risk while maximizing returns. Our approach is built on nearly a century of financial data and guided by leading industry experts. Here’s how we structure our investment portfolios to reduce risk and create long-term wealth stability.

[00:15:14] One, global diversification. Instead of betting on a single company, sector, or even country, we invest across global markets to capture broad performance. Two, broad market exposure. By investing in a wide array of companies, we avoid overexposure to any one stock, industry, or sector. Three, strategic asset allocation. We combine different categories of investments that respond differently to market conditions, helping balance risk. And four, bond allocations for stability. We use high-quality, short-term bonds to help smooth out market swings and create a more predictable investing experience. And our goal is to minimize risk and maximize return so you can build real, lasting wealth.

[00:16:03] Putting all your eggs in one basket isn’t a good idea for a reason, and that’s why diversification is key to financial security. And the best part is you don’t have to navigate this alone. You already did the hard work to earn your money. You can make the next step easy by letting us protect and preserve it. So, if you’re ready to create a smart selling strategy for employer stock or if you just want to understand your options better, my team and I would really love to help. Send us a message at hello@hendershottwealth.com or visit us online at HendershottWealth.com/contact and we can start talking about building a custom plan that works for you.

[00:16:41] But in the meantime, we’re not quite done here. Next up, let’s dig a little bit more into the tax implications of selling employer stock, and how you can actually keep more of your hard-earned money in your pocket. So, this is kind of the third section of today’s podcast episode, and I want to talk to you about optimizing costs and minimizing taxes. Now that we’ve covered why selling your employer stock is important and how to build a smart diversification strategy, let’s talk about that big, key piece of the puzzle, the one that gets in most people’s way when it comes to really thinking about selling and diversifying concentrated stock that’s in a gain position, and that’s cost and taxes.

[00:17:32] Because here’s the truth. The less you pay in fees and taxes, the more of your money stays in your pocket. And that can make a huge difference over time. One of the biggest benefits of a well-managed portfolio is lower costs. My team of advisors and I prioritize cost efficiency. Our global investment portfolios cost 0.26% or less of the account balance on an annual basis, and that’s far below the industry average of half a percent to a full percentage of the account balance on an annual basis.

[00:18:52] But it’s not about fees. It’s also about reducing your tax bill. And here’s how we can really help add leverage for our clients to keep more of their hard-earned money. First, we have been practicing investing in tax-aware funds for years. We use tax-managed mutual funds and ETFs that are specifically designed to keep transaction costs and capital gains low. Second, you’ve got to be doing tax loss harvesting. If you have gains, we strategically sell investments that have losses to offset those gains and reduce your taxable income. Third, tax-efficient rebalancing. When we adjust your portfolio, we do it in a way that minimizes unnecessary taxes.

[00:19:37] And fourth and the final thing I want to talk to you about today is something called Ultra Tax Efficient Wealth Management^SM. For clients with very large unrealized capital gains, it makes sense to take planning to another level. And that’s why we now offer extremely powerful, personalized investment strategies to help you keep and enjoy more of the fruits of your hard work. This is an incredibly powerful and potentially very profitable strategy to employ, and we’re going to be talking about it a lot more in episodes to come because, quite frankly, this Ultra Tax Efficient Wealth Management^SM approach is new-to-market. And you should know if it’s an option for you, it could be an absolute game changer for you and it deserves a spotlight.

[00:20:19] So, make sure you stay tuned. And if you cannot wait for those episodes to go live because you’re itching to put your wealth to better use, reach out to our firm to learn more about our ultra tax efficient investing strategies. Head to HendershottWealth.com/contact to book a free, no-obligation call with our team of advisors because we’d love to help you hold on to more of your money. Long story short, selling employer stock can come with significant tax consequences, but those consequences can be outweighed by the reduced risk and future gains in your wealth that you will earn by doing it, which is why we definitely recommend working with a financial professional to guide you.

[00:21:20] Getting the proper advice and guidance can help you time sales efficiently to avoid unnecessary tax hits, use tax loss harvesting to offset capital gains, and invest in tax-efficient funds to lower your tax bill over time. And now we may be able to do even more for you through Ultra Tax Efficient Wealth Management^SM. In conclusion, you really can take control of your wealth. Employer stock can be a powerful wealth-building tool and valuable part of your financial picture but only if you manage it wisely. By selling strategically, locking in gains, and reinvesting in a globally diversified portfolio, you can reduce your concentrated risk, protect your wealth, and create a more secure financial picture while still benefiting from the success of your company.

[00:22:23] The most important thing is to stay focused on the long term. We know that selling employer stock can be an emotional decision. It’s easy to get caught up in your company’s current dominance or stock performance, fear of missing out, or uncertainty about when to sell, or even just inertia that leads to total indecision. That’s why we partner with our clients to provide clarity, guidance, and education so they can stay focused on their long-term financial goals. And most importantly, we are independent fiduciary advisors. And that means you never pay commissions because we’re not selling you anything and we only act in your best interest. Our goal is simple, to help you build, grow, and keep your wealth. If there’s one rule to remember when it comes to investing, it is buy low and sell high. And if you’ve ridden the rise of your company stock and now it’s at an all-time high, selling is not just a good strategy, it’s a wise one.

[00:23:20] If this episode resonated with you and you’re ready to create a tax-smart, cost-efficient strategy for selling your employer stock and building a diversified portfolio, we’d love to help. Reach out to us at HendershottWealth.com/contact, and let’s build a strategy that protects and grows your wealth. And that’s it for today’s episode of Love, your Money^®. If you found this conversation valuable, be sure to subscribe, leave a review, and share this episode with a friend who might benefit from it. You can grow your wealth and celebrate each other’s wins together. I promise it makes them that much sweeter. Until next time.