There’s a reason your employer offers you a benefits package; it’s an incentive for you to stay with the company and a reward for your hard work and loyalty. Plus, if your employer can align your financial well-being with that of the company, it’s a win-win for everyone. One way employers do this is by offering an Employee Stock Purchase Plan (ESPP). Unfortunately, these kinds of programs can be difficult to understand and the fine print is enough to give you a headache. Let’s avoid the added stress by breaking down how these plans work and giving you some things to consider when deciding to purchase employee stock.
Employee Stock Purchase Plan Basics
In a nutshell, an ESPP is your employer allowing you to purchase company stock, usually at a discounted price. Since your employer runs the program, they make it easy for you by automatically and regularly withdrawing the money for the purchase from your paycheck.
During the “offering period,” you accumulate payroll deductions; then during the “purchase period,” those deductions are used to purchase stock. Then you simply own company stock and can do with it whatever you see fit.
While your company offers it as a benefit, participating in the ESPP is not always the best choice for everyone. Let’s look at why.
Why Should I Participate In An Employee Stock Purchase Plan?
The most obvious benefit of the ESPP is that you can get stock shares at a discounted price. The discount varies by plan and can be as high as 15%. Some plans even offer a look-back provision that makes it possible to get an even steeper discount if the stock price has gone up during the offering period. In addition to the price discount, you don’t have to pay commission fees on the purchase, which saves you even more.
The stock market can be very intimidating for a beginning investor. In fact, a lot of people avoid investing because it is too confusing. An ESPP makes investing easy. All you have to do is tell your HR department how much you want to invest and they take care of the rest. You get automated, regular investments in a company that you’re already familiar with and trust.
Potential Tax Advantages
If your ESPP is a qualified plan, as most are, then you can also get tax benefits not available with other types of investments. You realize these benefits when it’s time to cash out and sell your company shares. Certain rules must be followed to receive tax benefits, so you need to become familiar with your specific plan before taking action.
Why Should I Avoid An Employee Stock Purchase Plan?
As with everything, there are also potential downsides to participating in your ESPP. The major risk is one of the most well-known words when it comes to investing: diversification. Diversification is simply spreading your wealth around, not keeping all of your eggs in one basket.
If you’re mostly investing through your ESPP, then you could end up with a lot of your wealth tied up in only your company’s stock. That’s dangerous if your company performs poorly or even goes bankrupt. In general, it is better to have your wealth spread amongst various companies or even types of investments, so one poor performer only has a minor impact on your overall portfolio.
Not only do you need to diversify your portfolio, but your overall financial well-being as well. Your regular income is already dependent upon your employer. Do you want all of your investments to be dependent upon them as well?
If you have multiple income streams, then this may not be as much of a concern, but if you’re completely dependent upon your salary from this employer, it is an important thing to take into consideration. If something goes wrong, you don’t want to lose your job and all of your investments at the same time.
While they do offer nice benefits, ESPPs can expose you to more risk than necessary because of a lack of diversification in your portfolio and your overall financial life.
Questions To Ask Yourself
After considering the advantages and risks of an ESPP, you should ask yourself the following questions:
Would I be investing this money in stocks otherwise?
If there was no ESPP, what would you be doing with your money? If you would be investing it in the stock market, then the ESPP might be a great opportunity for you. But if other things would otherwise be more important to you, such as paying off debt, then perhaps the ESPP is more of a distraction from your true financial priorities.
Would I invest in this stock without the ESPP?
In the end, the ESPP is an investment and should be treated as such. You should research your company just as you would any other investment. After doing your research, would you still choose to invest in your company? If your company is a poor investment, then even receiving a 5% discount on the purchase price may not be enough to make up for the lack of returns you would get with a superior investment. However, if your company is a good investment, then your returns will be all the greater for the discount you receive.
Seek Professional Help
While an ESPP can be a great opportunity, whether or not you should participate in yours depends on your financial situation and goals. You need to make sure the ESPP aligns with both your short-term and long-term financial goals for it to be a wise decision.
An experienced financial advisor can help you determine how an ESPP can fit into your lifetime financial plan and whether your particular company’s plan is a good deal.
If you have an ESPP you’re considering participating in or you already hold company stock and want to make sure it’s the right strategy for you, we at Rubino & Liang Wealth Partners would be happy to discuss the situation with you! You can reach us by calling (617) 630-8787 or click here to reserve time for a 15 minute phone call to discuss your situation with us.