If you're fortunate enough to have worked at a start-up that's gone public, or if you have any sort of concentrated stock position, you've probably wondered if it's a good idea to hold on to the stock or diversify into the S&P 500. The desire to keep the stock associated with a company you've worked with for years is palpable and understandable, but the statistics paint a more sobering story.
Here, we'll look at the considerations involved in selling your concentrated stock position.
Arguments for keeping the stock
- You don't want to pay taxes ... yet. Depending on the type of equity you have, you'll be liable for any taxes due as soon as you sell your company stock. Note that you will ultimately have to pay taxes when you sell the stock, but you won't have to unless you sell -- an event that can be deferred years into the future if you choose.
- The stock represents a small part of your portfolio. If you're in the extremely fortunate position to have highly appreciated company stock as only a small percentage of your overall investments, you can almost think of it as a lottery ticket. Maybe it's the next big thing, but maybe it's not -- it won't matter much one way or another for you. But it's rare that investors finds themselves in this position.
- You're emotionally invested in the company's success. Not that acting on emotion is advisable, but it's also understandable that you'd want to hang on to stock for a company that you helped build. There's something unusual about putting in such hard work and receiving a proportionally growing prize in return -- it can be harder to part with stock than it sounds. Having some attachment is really very reasonable.
Arguments for diversifying into the S&P 500
- The past may not look like the future. Broadly speaking, rapidly growing start-ups are unable to sustain unusually high levels of growth indefinitely. Many start-up employees that have highly appreciated stock believe that because the stock has done well in the past, that it will continue to outpace the S&P 500 in the future. Research has shown repeatedly that the better bet to maximize long-term wealth is to diversify into the S&P 500.
- The pain of losing will outweigh the benefit of future gains. This connects back to the behavioral concept of loss aversion. Humans feel worse in magnitude when they lose money than they are happy when they win the same amount. For example, you'll feel worse if you start with $100 and end up with $95 than you would be happy if you were to start with $100 and end up with $105. Start-up equity is very difficult to come by, and the gains you've accrued are a combination of both hard work and good fortune. Rather than risk catastrophic loss, you could diversify into the S&P 500 to at least stabilize some of the gains.
- Your career is invested in the company, too. If you have a large swath of company stock in your back pocket, and you're depending on the company to keep paying and promoting you in the future, building in some diversification seems like a natural next step. Relying too heavily on the company you currently work for -- by holding too much company stock -- can unnecessarily increase the volatility of your collective human and financial capital.
Consider the middle ground
You don't necessarily need to sell all of your holdings in one go -- it's almost certainly better not to do that. But it does make a lot of sense to move out of your concentrated position in stages, which will smooth out any tax liability and also give you diversified exposure to other companies. Overall, this will help lower the volatility of your portfolio and build in some peace of mind.
Once you've accumulated a large amount of stock, your mind should turn to risk management. It's in your best interests to focus on preserving what you've worked so hard to earn while also maximizing your prospects for growth. Taking the best ideas from each side of the argument is often a good idea, and certainly you have that option if you find yourself deciding how to handle this.