80% of equity leaders said they believe the importance of equity in compensation programs will increase over the coming five years. Following the ‘Great Resignation,’ employers are ramping up their efforts to attract and retain talent.
After seeing an unusually high number of people leaving their current jobs last year, businesses are desperate to hold onto some of their most significant assets. One unique benefit many publicly traded firms now offer their workers is access to programs to become a shareholder in the company, often referred to as Employee Stock Purchase Plans (ESPP).
Employee equity options, are an attractive investment, but it may not be enough. Business owners surveyed by Morgan Stanley willing to trade ownership for loyalty are also sweetening the deal by offering shorter or more flexible vesting schedules and increasing employee education and communication.
While Employee Stock Purchase Plans are not new, the trend toward offering employees equity appears to grow further. And with the stock market down considerably this year, you may be able to purchase stock in your company at a steep discount.
The idea behind ESPPs is simple – to give employees the opportunity to profit from the firm’s success and participate in its growth. The thought is that employees who are also owners will be better at their jobs and more dedicated to the company and its success.
Participating in an employee stock purchase plan can be a smart way to build your investment portfolio. The key is to understand both the potential advantages and the possible pitfalls of these popular programs.
One of the advantages of an employee stock purchase plan is that it forces you to save and invest. Forced savings can help instill the kind of discipline needed to build a large portfolio over time. Simply learning to live on less than you earn can be a powerful lesson and one that can be extended to other investments like mutual funds, ETFs, and 401(k) plans.
Since the money comes right off the top of your paycheck, you never see it – or get a chance to spend it. In the financial world, this is known as the ‘pay yourself first strategy,’ and it can be remarkably effective at building wealth.
Another major selling point is the share discount. Depending upon the plan design, you may be able to purchase shares at a discount between 5 and 15%. A 15% discount means that shares currently trading for $50 on the open market could be yours for only $42.50 – a significant saving that gives you a profit from day one.
Of course, there is no guarantee that the stock price will not go down after the shares are purchased, and it’s important you do your homework before participating in your company’s ESPP. The same research that goes into any stock purchase applies to these plans, and it’s important to assess the financial health and future prospects of the firm with an unbiased eye.
It’s important to thoroughly read the fine print before signing up for an ESPP. Some firms impose special rules and blackout periods on the sales of shares by employees, especially those who may have inside knowledge of the company.
This could mean restrictions on when you can sell your shares, which could impact any future profits. So be sure to find out when you can sell your shares and how many shares you can sell. Understanding all the ins and outs of the program before you get started is essential.
One danger of ESPPs is that they result in too much concentration of a single stock. It can be tempting to load up on company stock, especially if the shares are offered at a deep discount, and you have enough free cash flow to invest.
It’s important to keep in mind, however, that putting too much of your money in any one stock can be risky. Keeping your investment in the company you work for to no more than 4-5 percent of your total stock portfolio is one way to mitigate that risk without giving up the potential for a healthy profit.
Examine your portfolio at least a couple of times a year, looking at your company stock in your ESPP and other stocks and mutual funds you own. If you find that your portfolio is overweight in your company stock, you can sell those shares and rebalance into other areas.
When you do sell your shares, hopefully, you will do so at a profit. After all, that is the whole idea behind ESPPs – to give ordinary employees a chance to profit from the firm’s success.
According to Todd Pouliot, financial advisor and President of Gateway Financial, you should consider the tax implications of investing through your ESPP to determine the taxable consequences of the sale of stock acquired through the ESPP.
If you sold your company stock for more than you paid, you would have to pay capital gains taxes on the profit. The percentage of that tax will depend on several factors, including how long you held the shares and your household income level. Talking with your financial advisor or tax accountant about the implications of selling company stock is always a good idea, especially if you’re considered a highly compensated employee.
An ESPP should not be your only investment; it is important to diversify your holdings. But if your employer offers such a plan, it is definitely worth your consideration. If you’re unsure what to do, find a financial planner who can help guide your decision-making process.
As a conscientious employee, you are already dedicated to the company’s success. Taking advantage of an ESPP allows you to profit from your dedication.
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Brian Thorp is the founder and CEO of Wealthtender, a leading personal finance website helping thousands of people each month find the best financial advisors, coaches, and educational resources to enjoy life with less money stress.