The tech industry pioneered the idea of using equity as a form of compensation for loyal employees. Nowadays, it’s incredibly common for equity to make up a significant portion of your compensation package—especially as you move up the ranks. But with varying vesting schedules, it’s far too easy to end up with more stake in your company than you realize.
Being concentrated in company stock may seem like a good thing, but it could put you at greater risk. Here’s how you can intentionally diversify your portfolio.
What Does Having a “Diverse Portfolio” Actually Mean?
One of the healthiest things you can do for your financial life is to diversify your portfolio. This entails having different types of investments in various industries and geographical regions.
Investment types like stocks, bonds, CDs, etc., range in their level of risk and growth potential. Having the right ratio of each provides some protection during times of market downturn while still capturing potential long-term growth.
Think you’re diversified enough? Ask yourself how much of your net worth is currently tied to your employer. Consider it holistically and include your salary, equity, benefits, bonuses, insurance, and anything else your company provides. When you add it all up, a lot of your net worth might be riding on your employer. That may put you in a riskier position than you realize.
Risk Tolerance & Risk Capacity
When considering how diverse your portfolio is, it’s essential to understand your risk tolerance and risk capacity. In other words, if your company shut down tomorrow and your equity was worth nothing, how much of a hit would your portfolio take?
As a general rule of thumb, tech employees should try to keep 10% or less of their portfolio allocated to equity compensation (though the exact percentage depends on your financial situation). If you find that you’re concentrated in that area, it might be time to sell and diversify out of your company stock. But how much you should sell depends on the other financial elements in your life, like additional income, tax situation, financial goals, and more.
Before selling any stock, check in with your financial advisor. There are often tax obligations to consider first. Each equity type comes with its own tax considerations, but let’s look at one as an example.
Say your company grants 50 RSUs. You meet the vesting requirements, pay the taxes, and now own company stock within your portfolio. If you hang onto those shares for at least one year before selling, you’ll get to pay the more advantageous long-term capital gains tax on the sale. But if you only retain the shares for 6 months, less favorable, short-term capital gains rates apply. And short-term capital gains are taxed at your ordinary income rate.
Selling your equity comes with important financial and tax ramifications. Let’s create a deliberate plan to see how you could make the most of this asset.
The Risks of Under-Diversification
The main driver behind having a diverse portfolio is risk reduction.
You’ve probably heard the saying, “Don’t put all your eggs in one basket.”
Here’s why: Say you invest all your funds into one stock. It could go really, really well, and you make millions. Or, it could go really, really poorly, and you lose it all.
While you may hope for instant riches, the potential for significant loss is real and can devastate your portfolio. By selling your concentrated position and reinvesting that into a diversified portfolio, you set yourself up for growth with less likelihood of such a dramatic loss.
How to Diversify Your Portfolio Outside of Your Company
Of course, there’s no “one size fits all” approach to investing. Everyone will do something a little different depending on their current needs and long-term goals. Various asset allocation models allow you to work toward your investment goals while accounting for your risk tolerance and season of life.
Diversifying your portfolio means including a mix of investments like:
- Exchange-traded funds (ETFs) and mutual funds
- Foreign and US-based companies
- Large, medium, and small companies
- Various industries like energy, tech, government, etc.
As you work with your advisor to create a diversified portfolio, it’s important to understand your equity position. You should know what you have now and what it’s worth, as well as any future options or current vesting schedules. Your portfolio and financial goals will likely change over time, so be sure to consider your short- and long-term goals when deciding on your investments.
Understand What You Have
Knowing what you have is the first step in making a plan that suits your long-term goals.
For example, if you already have significant equity holdings, it might make sense not to participate in your company’s employee stock purchase plan (ESPP) during the next enrollment period. Or, you might decide it’s best to sell a greater portion of your equity than you originally planned while continuing to invest in your ESPP.
Whatever you decide to do, know how your equity fits into your larger goals. Your long-term financial needs should dictate how your equity compensation works within your portfolio, not the other way around.
I Can Help You Diversify
One of the most effective ways to build a diversified portfolio that reflects your goals and tolerance for risk is to work with a financial advisor.
I help employees across the tech industry understand their equity compensation, build a tax-focused plan, and work toward building their desired lifestyle. If you’re concerned about your portfolio and the role your equity comp plays in it, don’t hesitate to reach out.