How to Incorporate RSUs into Your Investment Strategy

The philosophy that drives stock-based compensation is one in which key executives and employees (at WestStar we call them ‘Aviators’) benefit from the potential success of their company. It follows that they’ll want to maximize this benefit since they’re doing everything they can to make success happen. When it does, they are faced with the complex choice of selling or holding their shares.

If that sounds like you, then this is an article worth reading.

In an earlier article, we learned all about restricted stock units (RSUs) and how best to approach their complex management challenges. Click here to find out How to manage your Restricted Stock Units (RSUs).

(Links to ‘How Optimizing your RSUs will make a big difference to your success.)

To recap, RSUs, or restricted stock units, are a way in which your employer grants you stock in the company as part of your compensation package.   The grant is ‘restricted’ because you cannot sell or transfer it until certain conditions have been met.

Your restricted stock units are subject to a vesting schedule, which may be based on your term of employment and your personal and company performance goals, and be governed by other limits on transfers or sales that your company may impose.

When your ownership in the stock vests ─ meaning that the restrictions are removed over time ─ you own the shares and may hold, sell, or transfer them.

How Do You Decide Whether To Sell Or Hold?

After your restricted stock units vest, your choice to hold or sell your shares is an investment decision and will depend on your company and its growth prospects.

In some cases, it may be best to sell your shares when you receive them, and add the proceeds to a well-diversified investment portfolio. In others – where your company is performing well and looks to have a bright future – it may be best to hold them.

While diversification is a well-practiced and widely accepted investment approach, a concentrated approach may be more suitable for different individuals.

Read more on Understanding Restricted Stock Unit Taxes

What Is Concentrated Stock Risk?

A concentrated stock risk occurs when you own a stock that represents a large percentage of your overall stock portfolio. In this scenario, your wealth becomes ‘concentrated’ in this single stock. In percentage terms, an investment that accounts for 10% or more of your portfolio may be considered a concentrated position.

You can find yourself in a concentrated position as a result of many different circumstances:  the most common include your stock-based compensation package, the sale of a business, an inheritance, or the price rise of a single investment relative to the rest of your portfolio.

How do You Get out of a Concentrated Position?

Getting out of a concentrated position can be tough. There is a notable tendency for investors to hold a concentrated position, and this may have to do with their reluctance to sell an investment due to the capital gains taxes that selling may attract.

How do You Protect Yourself from a Concentrated Position?

Since selling outright may result in significant capital gains taxes, the simplest way to reduce your concentrated stock risk is by liquidating a portion of the stock and using the proceeds to invest in a more diverse group of securities.

Avoiding Behavioral Biases

Investors’ behavioral biases present another barrier to selling their concentrated positions. These biases include ‘anchoring’ (assuming the future will be like the past); overconfidence; the attraction to ‘long-shots,’ and underestimating the possibility of extreme events.

Understanding Concentrated Risks

Beyond these biases, many investors do not understand the significant risks associated with concentrated stock positions.  Firstly, concentrated stock positions are considerably more volatile than diversified portfolios, and thus represent a higher level of risk. Secondly, concentrated stock positions may underperform diversified portfolios over the long term.

A third risk lies in the assumption that your company will continue to prosper. When things go wrong at your company, not only does your stock suffer, but you might lose your job and your paycheck.

Avoiding the taxes that come with diversifying may not be reason enough to hold a concentrated position.

How ‘Concentrated’ Should Your Portfolio be?

Owning stocks in fewer companies means that more of your money can be invested into the highest quality companies with the highest expected returns. You will find that most investors hold between 15 and 20 stocks (at the least) in their portfolios.

What are The Differences between Diversified and Concentrated Strategies?

When comparing diversification and concentration investing strategies, many people find it easy to reference winning stocks – but only looking at higher-growth stocks makes it possible to forget that for every winning stock, you’ll often find a loser.

A diversification strategy is based on a simple premise: whereas stocks in the same sector will tend to move in the same way, companies operating in different sectors will be driven by a variety of diverse factors.

By allocating your investments in a variety of securities, sectors, and categories, you can grow your returns and safeguard your portfolio from volatility.

You can expect exceptional rewards for being concentrated in a winning stock, but the costs for being concentrated in a losing stock will be considerably greater.

What to Do if You’re in a Concentrated Stock Position

If you’ve held on to your RSUs and have capital gains taxes as a barrier to diversifying, there are a few things you can do.

Providing you haven’t maximized your 401(k), IRA, or HSA tax-deferred accounts, you can sell your RSUs to fund these contributions, and diversify your portfolio that way.

For those with charitable instincts, these shares can also be allocated to a Donor Advised Fund and used to fund charitable giving.

When we meet with clients who are seeking guidance as to how to optimize their stock compensation packages, we find many personal factors come into play in the debate between concentrated versus diversified portfolios. Our discussions are not about which strategy is better, but which strategy is best for them: and they get to share their financial goals and decide how much risk they’re willing to take.

Here are a few things you’ll experience when deciding on your investment strategy:

• You’ll get to understand the difference between diversified and concentrated positions.
• You’ll get to recognize the pros and cons of each strategy.
• You’ll get to learn how each strategy works.
• You’ll get to discover what sectors are better suited for each strategy.

WestStar’s Mike Smith explains the value of our personalized approach.

‘Many of our clients are earning stock compensation benefits that they find difficult to understand. They need advice that fits their personal life plan and the benefits they receive. To accomplish this we get to know a lot about them, so we can help them make smart decisions in optimizing their complex compensation packages and minimizing taxes, and so turn the opportunity to success.’

Mike Smith CRPC®, Financial Consultant.

Why Hitch Your Wagon to WestStar?

At WestStar we understand just how valuable RSUs can be in employee compensation plans.  To make sure you’re equipped with the knowledge and advice to pursue your investment strategy with confidence, don’t hesitate to contact us.

WestStar Prosperity Partners’ Advisor Team guides and mentors many highflyers. Our ‘advice in plain English’ approach brings confidence and clarity to managing your compensation programs, and we help you make and implement decisions with a long-term 360 ˚financial plan in mind.

Our advisors will help you turn the complex challenges into a clear flightpath to follow.

If you have questions about your specific circumstances, or want to make sure you’re equipped with the knowledge and advice to pursue your future with real confidence and clarity, please get in touch. We welcome the opportunity to chat with you.

To join our email list and never miss an update, or to find out more about our offices and advisors, please scroll down.

We wish you every success in the future and hope to hear from you soon.

Sam Gullette & Erik Alexander

Disclosures: “A diversified portfolio does not assure a profit or protect against loss in a declining market.”

“Distributions from traditional IRAs and employer sponsored retirement plans are taxed as ordinary income and, if taken prior to reaching age 59½, may be subject to an additional 10% IRS tax penalty.”

“The information on Health Savings Accounts (HSAs) provided herein is general in nature. It is not intended, nor should it be construed, as legal or tax advice. Because the administration of an HSA is a taxpayer responsibility, you are strongly encouraged to consult your tax advisor before opening an HSA. You are also encouraged to review information available from the Internal Revenue Service (IRS) for taxpayers, which can be found on the IRS website at IRS.gov. You can find IRS Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans, and IRS Publication 502, Medical and Dental Expenses, online, or you can call the IRS to request a copy of each at (800) 829-3676.”

“Generally, a Donor Advised Fund is a separately identified fund or account that is maintained and operated by a section 501(c)(3) organization, which is called a sponsoring organization. Each account is composed of contributions made by individual donors. Once the donor makes the contribution, the organization has legal control over it. However, the donor, or the donor’s representative, retains advisory privileges with respect to the distribution of funds and the investment of assets in the account. Donors take a tax deduction for all contributions at the time they are made, even though the money may not be dispersed to a charity until much later.”