Employee Stock Options: You Got to Knooooow When to Hold’em, (When to Hold’em), Know When to Fold’em (When to Fold’em)

. . .know when to walk away, and know when to run (are you singing along?). Ok, fine. Let’s get to the point.

This week I read an interesting article at The Simple Dollar. The question was when an employee should sell his or her stock options. The question was raised by a reader of the The Simple Dollar. Here’s the question:

I had a question about stock options that I was hoping you could answer. I work for a BIG internet company (you can probably guess which one). I have 114 stock options; a quarter of which vest each year for four years with a 10 year lifespan. The stock price is currently quite high, and I was wondering if you had such options would you cash out at a high stock price or hold on to them for the 10 year period. I don’t “need” the cash for living expenses or debt, but I don’t have very much for travel and other such things.

You can read Trent’s response to this question, but here it is in a nutshell:

If it looks like there’s still significant gas left in the tank for the company itself to grow, hold the options for now. You should wait until the instant your gut begins to tell you that the skyrocketing is slowing down or is over, then exercise the options and sell the stock.

Comments to the response were mixed. Some disagreed with Trent’s advice:

I have several friends who work for Google. Two have told me that they cash out their options right when they vest (and plow it into other investments) as a form of risk diversification. After all, they are employed by the company; if the company starts to go south, the options will be worth much less, and they will be in danger of losing their jobs. It’s got nothing to do with their appraisal of the company or with the current stock price.

Others were more sanguine:

If you already have a diversified portfolio and the options are in such a strong company like Google, then keep them. Even if it constitutes a huge portion of your net worth. Why do I say this? This is a once in a lifetime opportunity to score. You can multiply your net worth a ridiculous number of times by just sitting on options. Of course, if your assets are all riding on this one position then it would be a mistake not to diversify out of it. It’s worth keeping an almost free concentrated position in a hot stock/company if the rest of your finances are already in order.

This last comment came from The Digerati Life, a blog I read regularly.

Since I like a bit of controversy and even constructive disagreement (and because I’ve owned company stock in the past), I thought I’d weigh in on the discussion. So, for what it’s worth, here are the 4 considerations (in no particular order) that I believe should go into a decision to sell or hold your company’s stock:

  • Objective and Unbiased Evaluation of the Company: You should evaluate an investment in your employer as you would any other investment. As an employee, as Trent rightly points out, you have a view of the company that outsiders don’t have. This can be both a blessing and a curse. I’ve found it very difficult to evaluate my employer’s future prospects with the stoic precision that a Warren Buffett brings to his investment decisions (no, I’m not comparing myself to WB). The point is, if you can’t evaluate an investment objectively, then you can’t trust your evaluation.
  • Diversification I: In my view, no single position should comprise more than about 10-15% of your overall portfolio. If you have any doubts about this, read some of the horror stories from former Enron employees. Keep in mind that this is my general rule of thumb. If I had more money than I knew what to do with (I don’t, by the way), than I might be willing to risk more of it than 10-15%. But for us working stiffs, in my opinion, 10-15% (maybe 20%) is the most that should be invested in an employer.
  • Diversification Part II: With investments in your employer, you incur a double risk. If the company goes down the tubes, you not only lose your job, but your investment in the company goes with it. See Diversification I above.
  • Taxes: Let me just say that the tax implications are complex, and vary depending on exactly what vehicle you used to acquire the stock. Was it, for example, a standard option, part of an Employee Stock Purchase Plan (ESPP), or a Ristricted Stock Unit (RSU). The taxes can vary and you should assume that common sense has no place in figuring out your tax liability (I learned this the hard way with my ESPP). You also have to consider the implications the income will have on potential Alternative Minimum Tax (AMT). In short, consult your tax adviser.

If you think other considerations should go into the mix, or disagree (or agree) with my list of considerations, post a comment.

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