Why Employer Stock Is One of the Riskiest Investments You Can Own

I have a client who works for Apple. He’s been there for years, loves his job, makes good money, and would like to spend the rest of his career there.

He’s also fortunate enough to participate in a restricted stock program, which in his case means that he receives a pre-determined number of shares of Apple stock every six months. He’s taxed on the value of those shares, but other than that they are 100% his to do with as he pleases.

Now, Apple has been the darling of the stock market for the past decade-plus. A quick look at Morningstar’s charting data shows a mountainous climb since 2005, and that doesn’t even factor in all the dividends it has paid over the years.

Today it stands as the largest public corporation in the world, a testament to its long run of outstanding performance.

And despite all of that, every time my client receives Apple shares I recommend that he immediately sell them and invest the money elsewhere.

This recommendation has nothing to do with my opinion of Apple. Honestly, I’m not in the business of predicting which specific stocks will outperform and underperform in the coming years. Almost no one can do that reliably and I am certainly not one of the lucky few.

My recommendation comes down to the simple fact that employer stock is one of the riskiest investments you can own, even when your employer is one of the most successful companies in the world.

The Danger of Concentration

Owning employer stock is simply an extreme case of failing to diversify your investments.

Diversification is the time-tested investment principle that says that you’re better off spreading your money across a number of different investments as opposed to putting all of it into a single investment.

For example, diversification says that instead of investing in a single company, you should invest in an index fund that represents the entire stock market. Or at least a big enough subset of the market to prevent any one company from having too large of an impact on your overall return.

The power of diversification is that it is the only investment strategy that allows you to reduce your overall risk without reducing your expected return. The only one.

The flip side is that there’s a lot of risk in investing too much of your money in any single company.

Unless the entire U.S. economy fails, a U.S. stock market index fund can only lose so much value. For example, the stock market lost about 50% of its value during the financial crisis in 2008 and 2009, which was a lot. But even at the very bottom of that decline, you still would have had about half of your money left.

But any individual company can go bankrupt, meaning your investment in that company could go all the way to $0. That’s the risk of being undiversified — that you could lose everything with a single bad bet.

And the risk is doubly great when you’re talking about employer stock.

The Double Risk of Employer Stock

Simply by working for your employer, you have already staked a substantial percentage of your personal financial success to that one company’s success.

You rely on that company for your income, which is what fuels your ability to pay bills, save money, and invest in your future. If the company succeeds, odds are that your income will continue and maybe even increase. If the company fails, your financial prospects could falter along with it.

In other words, your personal financial risk is already intertwined with your employer’s financial risk.

Adding investments in that same company’s stock only increases that risk because now both your income AND your investments are heavily dependent upon your employer’s success. If your company runs into trouble, you could potentially lose your job and face a significant investment loss at the same time.

That’s why investing in your employer’s stock is one of the riskiest investments you can make, even if you work for a company like Apple.

It’s as undiversified as it gets.

When It Does Make Sense to Buy Employer Stock

Given the risk, is it ever a good idea to invest in your employer’s stock?

The short answer is yes, but generally only under very specific conditions.

Some companies offer an employee stock purchase plan (ESPP) that allows employees to buy company stock at a discount. Some of these plans then allow employees to immediately sell that stock, essentially guaranteeing a profit as long as the process is managed correctly.

In that scenario it can absolutely make sense to purchase employer stock. But even then it’s only to the extent that you sell it as quickly as possible, locking in your profit and subsequently moving to a more diversified investment portfolio.

The real risk in this scenario is behavioral. A study by Ilona Babenko and Rik Sen found that over 45% of employees participating in these plans never actually sell the stock, maintaining the highly undiversified portfolio and the associated risk.

If you can implement a disciplined process of buying the stock at a discount and selling as soon as possible, an employee stock purchase plan can be profitable. If not, you may simply be falling into the trap of taking on more risk than you should.

Eliminating Unnecessary Risk

Financial planning always involves taking calculated risks. We never know exactly how the future will go, but we have to plan for it anyways.

Investing itself is a risk, with the expectation of positive returns but no guarantee that you will actually receive them.

Risk is unavoidable, but a good financial plan does what it can to eliminate unnecessary risks that needlessly put your financial future at risk.

And with your income already dependent upon your employer’s financial success, owning employer stock almost always falls in the category of an unnecessary risk.

Related Articles:

Matt Becker, CFP® is a fee-only financial planner and the founder of Mom and Dad Money, where he helps new parents take control of their money so they can take care of their families. His free book, The New Family Financial Road Map, guides parents through the all most important financial decisions that come with starting a family.

The post Why Employer Stock Is One of the Riskiest Investments You Can Own appeared first on The Simple Dollar.

Contributer : The Simple Dollar http://ift.tt/2jgs0Cy