Smart Money Tips

Concentration Risk: How Much is Too Much Equity in Your Employer ?

  • Concentration risk must be thoughtfully managed so that employees do not own an excessive amount of company stock and options
  • You should aim to have no more than 5% to 15% of your net worth in employer equity
  • A robust financial plan looks at the big picture and aims to reduce risk with the client’s goals and time horizon front and center

One of the most exciting aspects of working for and having a stake in young technology company is earning shares and stock options, then seeing the firm grow in value. You feel like you’re hitting home run after home run when things go right – your net worth swells and your career advances. You also feel as if you are on a championship team and all that arduous work is paying true rewards.

That’s the upside. There is a downside. The company may endure tough times, too. It is then when so many employees at tech startups wish they had diversified away from high exposure to a single firm.

What is Concentration Risk?

Concentration risk is simply having too much equity exposure to one company. But it’s often hard to calibrate the ideal amount of stock to own in a firm. After all, different stocks carry different levels of risk. Microsoft, for example, is much different from a volatile start-up.

While rules of thumb are helpful, it often takes the expertise and experience of a financial adviser to ensure that you are not taking on more risk than you can afford. A comprehensive approach is needed whereby your risk tolerance, time horizon, other assets, and goals are all reviewed along with shares in your employer’s stock.

Analyzing Your Assets and Sources of Income

Assessing concentration risk is not confined to the percentage of your net worth tied up in company shares, though. There’s an additional risk because you work for that corporation, and your income is dependent on its success.

In a perfect world, people would separate their financial assets from their salaries. That way, the peril of one area is less likely to negatively affect the other. Diversification between the two is often the goal when working with tech industry professionals, but the same strategy applies to so many other job types and regions across the country.

A High Equity Percentage Is Common in the Tech Sector

It’s not unusual for workers in the technology sector in particular to amass a very high equity stake in their employer. Concentration mounts quickly when you receive employee stock options (ESOs), restricted stock units (RSUs), and purchase discounted shares in an Employee Stock Purchase Plan (ESPP). When the values of those options and shares rise, so too does your concentration risk.

The Behavioral Component & Game Plan

It is common to want to continue holding those assets. There’s a real emotional attachment when you are given shares as part of your equity compensation package. You earned it, were rewarded for your hard work, and might still believe in the company. Still, risk must be managed objectively. It’s crucial that we take risk off the table and dial back your portfolio’s volatility.

Here’s what you can do:

  1. Take an inventory of all current holdings and what you expect to receive in the next six months to a year through stock options, unvested RSUs, and planned ESPP purchases.
  2. Then assess the value of your other current investable assets and cash.
  3. Next, divide the value of employer stock by your total investable assets. What’s the percentage?

Concentration in the employer’s shares should not exceed 5% to 15%, depending on your specific ability, willingness, and need to accept risk as well as your overall financial priorities.

So much of wealth management and personal finance is about harnessing emotions and managing behavioral biases. There’s a great tactic we find helps clients take an objective look at how much equity to have in their employer’s stock.

Ask yourself: If you weren’t awarded this many shares, would you buy this many in the open market? If you didn’t work for this firm, would you buy this number of shares?

We find that the objective answer clients arrive at is often a resounding “no.” That’s important because it means we should construct a strategy that smartly reduces equity exposure to diversify assets. Of course, we want to avoid paying excessive taxes and still want to capture lucrative share-based incentives.

The Point: Managing Total Risk

It’s also critical to recognize the broad goal here. There is no promise or expectation that diversifying away from your company stock will increase your portfolio’s return. The objective is to arrive at your financial goals safely and reduce volatility and total risk along the way. We can do scenario analysis, run Monte Carlo simulations, and perform stress tests on your equity comp, taxation, and concentration to ensure your financial situation is on the right track.

The Bottom Line

A strong financial plan identifies goals and risks with the investor’s time horizon top of mind. Holding too much equity in the company for whom you work is a common risk in many industries. While there are rules of thumb and helpful steps you can take, that risk should be managed by a professional with an objective and expert view.