Company stock and the risk to your financial goals

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The Salesforce stock purchase plan was the first real investment I ever made.

It was 2015 and I had joined the company a few months previous. I had no idea how it actually worked or whether it would be a good investment. I was as ‘green’ as it gets. Complete ignorance. In the end, it turned out to be a great first step - It was effortless. An opportunity to partake in the company's success and the process was almost fully automated. It was also a great segway into the world of investing. Shortly after my peers and I joined the Employee Stock Purchase Program (ESPP), it no longer felt like this scary thing and as the years went by, I noticed how people spoke about their stock options and other investments they were making outside of Salesforce. Everyone's financial literacy had made a significant jump. We were investors.

The problem I found is that if you let your position build up over time you end up with most or maybe all of your investment sitting in a single company. Not exactly a great strategy. 

It's not easy to build a diversified portfolio with a sufficient mix of investments and asset classes. Firstly, it requires discipline. Discipline to invest a portion of your salary in something you expect to leave untouched for a long time. Maybe decades! And if you’re working at an interesting company, whether private or public, that has the potential to grow significantly and provide a big return, it can seem counterproductive to take your money out and move it into other investments that might grow slower.

Maybe you work in ‘Big-Tech’ and are part of a stock options plan. Think about your own situation. If you have a large portion of your portfolio in a single stock, you have an overly concentrated stock position. Company founders, board members, senior management and other employees who might work for a public company and be compensated in part in its stock often end up with concentrated positions.

It's also a regular problem for employees of private startups. Everyone wants an opportunity to own a chunk of the next Meta, Uber or Airbnb. If you’re given the opportunity to exercise your stock options in a hot startup you’ll likely be hesitant or totally against passing up that opportunity and instead invest in a mix of other assets. 

And I don’t blame you! In the right company, having a concentrated position in a single stock can be very lucrative. The problem is it's impossible to know and time the right company. If you have stock options in a great company with the potential to grow exponentially, you could make a lot of money. The problem is, you could also lose a great deal too!

How concentrated is too concentrated depends on your financial goals and the amount of risk that you’re willing to take to achieve them. For someone younger with financial goals that are significantly more ambitious than their current net worth could support, it may make sense to be more concentrated in an individual company as that single position has potential for a lot more upside. Obviously, there’s no guarantees. In fact, the odds are heavily stacked against you, but there’s still a small chance for a home run with a concentrated approach.

On the other hand, the closer you get to being able to fund your financial desires with your current net worth, the less it makes sense to make big bets on any individual outcome.

When it comes to private startups, one of the biggest issues is that you can’t easily sell your stock or exercise your stock options. There’s usually a vesting period and other milestones that need to be met before you can do so. Either way, the best time to sell/exercise your options is after a liquidity event like the company going public or being acquired. This means you might not have much choice but to sit on your concentrated position and hope for the best. 

For those at early-stage startups, it can actually cost money for employees to exercise the stock options that are part of their compensation. Many employees end up needing so much cash to buy into the businesses they work for that they end up compromising other investment goals. Most companies will offer loans to allow employers to exercise their stock options though. But this can create a bunch of other complications. 

Stock plans in public companies tend to be smoother and give more opportunity to exercise your options. At Salesforce, there were two windows a year that allowed you to exercise your options or sell your stock, but like I mentioned earlier, a lot of people let their stock build up over time as the share price grew.

I know people who would have started long before me and who made significant money. Like, buy your house with cash type money. Which, for an employee stock purchase plan in a public company is pretty great.

Now the people who did well joined at the right time. They didn’t know it was the right time, they just got lucky!

And as far as my own experience, I’ll admit I didn’t take advantage of the ESPP like I should have. Regardless, I still made money. But again, that was through no strategy; I was just fortunate enough to be at a great company. 

Maybe you’re also working in big tech and this sounds familiar. Ask yourself, ‘what portion of my portfolio is made up of a single position?”. There’s no rule of thumb. Some say it shouldn’t be more than 10-20% but I think it's better to look at it this way - If a major loss in your concentrated position will break your financial plan, then you’re too concentrated.

And before you think that could never happen to your stock or your employer, trust me, it's a very real possibility. According to a 2014, J.P.  Morgan whitepaper titled ‘The Agony and the Ecstasy: The Risks and Rewards of a Concentrated Stock Position’, around 40% of all stocks experienced catastrophic declines. A catastrophic decline is defined as a 70% decline from peak value with minimal recovery. And when you look at it by sector, Tech companies fare even worse than the average, with 57% experiencing a “catastrophic” loss over the period studied.

Maybe your company will be different, but are you comfortable risking serious money with those odds?

Let's look at some well known tech companies and how their stock performed between the end of 2021 and 2022. This was the biggest dip the market had seen for some time. And while it was just one year, this would have been a year when many employees had major financial outlays. Houses, new babies, new cars etc. who planned on exercising their options to help pay for those things. And while I think a long term strategy is best for 99% of people, you can’t determine how the market will be doing down the road when you might need that money. 

The below shows the rough price of these stocks in the last week of November 2021 when the stock began to dip to the same time 12 months later.

These are just examples, but they are very much real scenarios. And depending on the company, we’re talking about a loss of anywhere from 30% to nearly 70%. If you think you couldn’t survive a similar scenario or you would have to drastically reduce your financial priorities if it happened to you then it’s time to diversify.

For the average person, the options usually still mean investing in stocks. Money opens doors. That's why wealthy people can access the best financial opportunities. The rest of us deserve the same.

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The Unsophisticated Investor is brought to you by Scott & Rob, the founders of PitchedIt. We’re both sick of private markets being a playground exclusive to the ultra-wealthy so we started a company to challenge the status-quo. PitchedIt’s singular focus is to unlock private markets for Millennial and Gen Z retail investors and help them build wealth through the highest performing private market opportunities.

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PitchedIt Co-Founders