Is an Employee Stock Purchase Plan a Better Bet Than an Index Fund?

In this segment from this Market Foolery podcast, host Chris Hill and senior analysts Jason Moser and Taylor Muckerman weigh in on a question that many people may have about their employee benefits. P.J.'s employer will allow him to buy up to 10% of his after-tax salary in company stock at a discount. That looks like free money, in one sense, but it's a risk in another. Should he max that option out or diversify, and if so, how?

A full transcript follows the video.

This video was recorded on Sept. 10, 2018.

Chris Hill: From P.J., who writes, "I've recently been given the option to take part in my company's employee stock purchase plan. I'm allowed between 1% to 10% of post-tax income to purchase company shares quarterly at a 15% discount, vested over five years." Goes on to write, "Fellow employees have been encouraging me to put as much money as possible into this plan due to the large discount on share price and our company's track record. As someone in my young 20s now, my only qualm is that buying into a single stock, even my own company's, seems to be putting too many eggs in one basket. I feel that buying into a simple S&P 500 ETF would over time prove to give back larger gains. I'm curious what your opinion is on this matter. Thanks."

Great question, P.J.! We've gotten this version of question from different people over the years, Taylor. On the one hand, we love a good discount.

Taylor Muckerman: Yeah, no doubt!

Hill: Whether it's on a Casper mattress, or our own company's stock, we love a good discount. Particularly for people who are in a 401(k) plan where there's company matching of any sort. I mean, that's just free money. That's great. As the youngest person in the room, what do you think, on this area?

Muckerman: First off, great for being this open-minded about investing in your 20s, and willing to commit some capital to it. But for me, personally, 15% is a great discount. They are vesting over five years, so you're quasi locked in to being a long-term investor. Definitely want to feel comfortable with the financial standing of your company.

But, for me, personally, I wouldn't max out. Not only are you getting this company's shares, but this company is also paying your paycheck. You're more beholden to its success in just the stock that you're investing this money into. For sure, I would take advantage of some of it. But I probably wouldn't be maxing that out myself. Max out the match in your 401(k) and then diversify a little bit. But I probably wouldn't max out my holdings with just that one stock.

Hill: Jason, what about you?

Jason Moser: Who are these employees who are pushing you to make this purchase and max it out? I'd ask for their track record, frankly. I mean, what do they know? Seriously, in all honesty, I do wonder. If everybody's sitting there telling you to do it, that's one sign for me to maybe take a step back and think, "OK, what's the other side of this coin? Let's flip this thing on its head."

I think Taylor really hit on one of the most important points. That's your employer. You have a lot of exposure there, just in getting your paycheck every couple of weeks. I keep that in mind with any of that. Also, we love a discount, like you said, but valuation when it comes to stocks is more art than science. It doesn't always make sense. You have to always keep that in mind. At your age, you can take a lot more risk, no question about it. But I also like the thinking, in the question there, about investing into an S&P index fund and letting that letting that roll. I do think, for any employee that's taking advantage of their 401(k), max out what your employer will match. Really, I think the only vehicle you really need to have is that S&P 500 index. You keep on averaging into that over the years, through thick and thin, and you'll be very happy with the results.