This Article Was Previously Posted on www.SacramentoAdvisorsNetwork.com
Advice that is perfectly “by the book” does more for the giver of the advice instead of the person that needs to receive it. It is easy for me to tell someone to exercise for 30 minutes per day and eat 5.5 servings of fruits & vegetables, but the person is most likely not going to implement it consistently. Instead, a more practical and personal approach is far more likely to lead to results.
When it comes to public companies, many employees have Restricted Stock Units (company stock) as a piece of their compensation that vest either monthly, quarterly, or annually. The “by the book advice” is to sell the shares ASAP and deploy the funds elsewhere (diversify). We hear this all the time, but we rarely meet someone that does exactly that. To us, that means the advice is bad or needs to be communicated in a different way.
First, let us unpack the logic around that “by the book” guidance. RSUs are nothing special, and it is the exact equivalent of your company giving you a cash-bonus, then immediately purchasing stock.
Example: A $10,000 bonus of cash leads to $7,000 hitting your bank account after taxes. With RSUs, the $10,000 bonus still leads to $7,000 after taxes, but the company automatically purchases stock instead of sending the funds to your bank account. If you sell the stock immediately (reversing what your employer defaulted) you still end up with $7,000.
The question (rhetorical) is: If your company gave you a cash bonus, would the first thing on your list be to rush to your computer/phone, transfer money to your investment account and put 100% of the funds into the stock of the exact company that you happen to work for?
99.9% of the time, the answer is no. For many folks they may save some of the money, spend some, and invest some.
We (humans) like the path of least resistance. We have thousands of thoughts and make thousands of decisions per day and are always seeking mental shortcuts to save energy. Our brains would not be able to function if we carefully weighed the pros and cons of every little decision we made. This is a feature not a bug.
Richard Thaler won the Nobel Peace Prize for economics based on this one basic idea: “Nudging” people in the right direction has a much better impact on their behavior versus educating them. We can teach people all day long about personal finance, or we can simply default 3% of their paycheck to their 401(k) and let them decide to opt out. Most people will not opt out.
Nudging is exactly what happens with RSUs. The funds are nudged (or forced) into the company stock, and most people do not opt out.
Though the standard advice of “sell everything immediately and diversify” is advice based in logic, most people do not follow it. Below are some alternative scenarios one could utilize in their situation when it comes to their regular RSUs vests.
Hold Some, Sell Some
One of the reasons employees hold, is the FOMO factor or Fear Of Missing Out. If the company does well and everyone benefits, you want to participate and benefit from that. If the company stock does not do well, at least you “failed” with other people by your side. When thinking about the “worst case scenario” it is likely one that involves selling all RSUs while the company stock price shoots to the moon. In your mind, “everyone won and I lost.”
Selling a portion and keeping a portion of your shares allows you to hedge your bets in a way. You are avoiding falling victim to the default nudge, while still having some “skin in the game” with your company. With the RSUs that are sold, you can easily diversify your investments, or do what you please with the funds. If the stock does wonderfully, you still win. And if the stock does not do well, you are somewhat protected due to your diversification.
Hold until you hit a target percentage
With investing, it is helpful to look at things in both dollar terms and percentage terms. Even though auto-selling the RSUs is nice, logical advice – if it only amounts to 0.5% of your portfolio, then it does not matter too much.
On the other hand, I have seen many situations where RSUs were essentially ignored for years and turned into 40% to 90% of a portfolio. Sometimes this ends up being an excellent problem to solve (large capital gains), other times it is disastrous (major decline in stock price).
One method is to come up with a target percentage that you are comfortable with (2% to 10%, for example) and holding all of your RSUs until you reach that point. Once you are at the target percentage, you can sell all future vests (effectively opting for a cash bonus) and re-deploy the funds elsewhere. If the stock price declines, thus reducing the percentage allocation, you can simply hold some additional shares to get back up to your target percentage.
Brainstorm in Advance:
Regardless of your exact approach, it always makes sense to have some semblance of a plan or approach ahead of time. Otherwise, we tend to get caught up in the movement of the stock price. After a few rough quarters, we decide to sell (low) and diversify. And after a few amazing earnings reports, we never consider selling. In addition to potentially poor, undesired outcomes – the lack of a plan leads us to utilizing a lot of time/energy each quarter to consider what to do with the stock. Setting up a plan in advance allows us to better use the time and energy towards more fruitful/fun/productive activities.
At the end of the day, we want to be mindful and intentional when it comes to our finances. Though “nudges” or defaults can be a good thing, it is important to be aware of them. Though convenient, sometimes we forget that we have a choice. No matter what your approach is with your company stock, the plan is usually the same. Hope the price soars, but prepare for the scenarios where it does the opposite.