One Very Simple Strategy for Managing Equity Compensation
A version of this article was written for & originally published on Business Insider
Have equity compensation and feel overwhelmed by the decisions you need to make around it? Don’t let that stop you from managing it well!
Whether you want to prioritize simplicity, eliminate as much risk as possible, or reduce the amount of difficult choices you need to make in your financial life, this basic approach to managing your equity compensation can help you avoid analysis paralysis and actually allow you to leverage the equity you own.
First, Know What You Have
Before we get to the basic outline of what we often recommend, there are a few caveats to bear in mind. The most important is that equity compensation gets complicated, and fast.
There’s not just one type of equity you could have, and you need to be very clear on what you own before you make any choices or decisions. Incentive stock options and non-qualified stock options might both be “stock options,” but they are treated and taxed differently.
Mistaking one for the other could lead to serious financial consequences. If you have equity compensation, it is well worth reaching out to a number of professionals to help you, including a financial planner and a tax advisor or CPA.
It’s nice to have an idea of what you’d like to do with your equity, and this outline can help if you want to keep it simple.
But at the end of the day, your equity compensation presents a big opportunity and equally big potential downside risk.
A team of professionals can help you manage that in a way that’s appropriate for you, in the context of a larger financial plan.
Then, Get Educated on Concentration Risk
One of the factors that makes equity come potentially dangerous is that it inherently creates a concentrated position in a single company within your overall portfolio of assets.
Any investment in the stock market comes with market risk. As an investor, there’s not much you can do about that.
And it’s not necessarily a bad thing; without risk, there’s no potential for reward (which, in this case, is the investment returns you can earn).
However, holding one specific stock also comes with additional, acute risks. Those include company, sector, business and legislative risks, among others. You can reduce or potentially remove those risks through proper diversification.
The concentrated position that owning equity in the company that employs you exposes you to these extra investment risks. If you do nothing to mitigate that, you likely reduce your long-term probability of success.
Not to mention, you’re already “exposed” to your company whether you have equity comp or not: they provide your paychecks and probably other valuable financial benefits too, like a retirement plan that might come with a match.
If something happens to your company (or your position with it), your income is already at risk. Add in a big portion of your investment portfolio being made up of company stock, and then you also put your overall assets and financial risk in peril, too.
Again, diversifying appropriately can help here… and that’s where our basic strategy for managing your equity can come into play.
Finally, Consider This Straightfoward Strategy for Easy Management of Company Equity
The key is to be proactive with your equity compensation. It’s very easy to let a super-concentrated position in your company’s stock build up over time if you’re not paying attention.
That’s why a simple approach is to simply sell the equity you receive upon vesting, and reinvest the proceeds (less any money you need to set aside to pay for taxes) back into a globally-diversified portfolio.
In practice, that could look like selling shares as soon as you are able to do so, setting aside the appropriate amount (based on your tax rate) that you will owe to the IRS when you file your taxes for the year, and contributing the remainder from the sale into a taxable investment account for long-term growth.
Or, if you have known short-term goals, you could take the proceeds from sales of shares and use them to fund those. You can then repeat this process any time you receive new grants of equity throughout your time at your company.
Again, this is a simplified approach to managing your equity compensation, and it prioritizes minimizing concentration risk and avoiding market timing above things like optimizing for the lowest-possible tax rate or hoping to secure the biggest possible gain from the sale of your shares.
Depending on your situation, you may want to use a different strategy that is more complex, requires more management, or presents you with more risk. This is where a team of professionals can help chart the right course for you and what you want to achieve.
If you’re ready to optimize your financial life and enjoy the confidence that comes with knowing you’re making all the right money moves, start here.