Selling Employee Stock Options? Decide in 7 Steps

One of the most stressful financial decisions is whether or not to sell employee stock options that we receive as part of our compensation. If we sell now and the stock goes up, we feel like a fool, and if we don’t sell and the stock goes down, we feel even more awful.

To break the cycle of second-guessing yourself, follow these seven steps to guide your decision on whether to sell the stock so you can keep your personal finances stable for the long term.

Step 1: Remember that even founders sell some of their stock.

The top management of the most successful companies sell some of their stock. They do it for the financial well-being of themselves and their families. Having all of your wealth tied up in one company is not prudent since there are so many factors beyond a company’s control that can impact their success. Selling some of your stock does not mean that you don’t believe in the company.

I am aware of only one founder who has minimized selling company stock and it is Larry Ellison of Oracle. Instead, he borrows money to support his lifestyle and uses his stock as collateral for the loan, which brings up a whole other set of risk factors. Hello, margin calls!

For everyone else, selling at least some of the stock to establish a more secure financial nest egg is prudent. But how much should you sell?

Step 2: Add up all of your cash and investment accounts.

Start with the value in your 401k account and consider the following:

• • Add IRAs or other retirement accounts
  • Add savings and checking account balance
  • Add any other financial assets
  • Add the value of the vested stock = Total value of your financial assets¹

The value of your vested stock ÷ the total value of your financial assets =
Percentage of vested stock of your overall financial wealth

The following are important questions to explore when you ask yourself: should I sell my stock options?

• How much does your vested stock represent of your financial wealth? Is it 20%, 50%, or 75%?
• If the stock price doubled, would that change your lifestyle?
• If the price of the stock fell by half, would that change your future plans?
• Do you feel comfortable having this percentage of your wealth tied to one company?
• What percentage seems reasonable to you?

Step 3: Stop obsessing about the stock price.

The decision about how much company stock to keep or sell is not about the stock price. It is about deciding what size retirement nest egg that you will need to be comfortable IF the stock goes down.

The smartest analysts on Wall Street do not know where your stock is headed.  The top management of your company does not know where the stock price will be a year from now, or two years, or ten years. This is not about the stock price.

This is about balancing your need for a financial nest egg in case the stock falls, while also holding some company stock to potentially grow your wealth.

Step 4: Keep perspective.

It is very easy to fall into the fantasy of thinking about what our lives would be if we had endless wealth. Try to balance those thoughts with thinking about how fortunate we are that this gift fell into our laps.

Many people work harder than we do and have less to show for it.  We work hard too, but we need to recognize that some of it is due to luck of being in the right place, at the right time.

Step Five: Pick a number.

To determine how big your secure nest egg needs to be if you want to live independently (if that is your goal, of course), try a simple formula.

Start with how much you think you spend in a year ($75k? $100k? $200k?) and divide that number by 0.05 =
This is the dollar amount you need in savings in order to live your current lifestyle, without touching the principal, at a 5 percent investment return.²

If a 5 percent investment return seems high or low to you, recalculate with different percentages to see a range.³ The concept is that the savings required to live financially independent is based on: a) your spending needs, and b) the returns you achieve on your investment portfolio.

Maybe you have a different goal. If so, pick a number and use it as your guide instead.

Step 6: Start with your stock options and end with focusing on your future goals.

Determining how much of your stock to sell or not sell should be driven by the overarching goal of what you ultimately want to do with the money.  No one wins a gold star by having the biggest bank account when we die, but no one wants their money to run out either.  Step Five gave you a number, so this is about asking yourself what you really want.

Step 7: What to do with the money when you sell the stock?

The hardest thing is deciding whether or not to sell your stock options — and how much. The second hardest decision is figuring out what to do with the cash after you sell it.

The Do-It-Yourself method

This method is the cheapest way. Simply, open a free brokerage account online. My favorite investment house is www.Fidelity.com because they offer free accounts, they are financially sound, and they offer the widest variety of bonds.⁴ All investment brokerages offer similar stock index funds, but it is harder to find a good selection of bonds. Even if you don’t want bonds now, you may want them in the future.

Transfer the cash into your investment account. If you are comfortable with risk (i.e. stock market), buy a low-cost stock index ETF.⁵ My favorite is iShares S&P 500 Index, the ticker is IVV. Fidelity does not charge a commission to buy this fund.

If you are risk-averse, call the Fidelity rep and have them help you buy a “laddered, investment-grade, U.S. bond portfolio." Use those words.⁶

You want to buy the actual bonds and not a bond fund because you get more downside protection by owning the actual bonds.  When you hold a quality bond to its maturity date, you then receive the full face value of the bond even if prices fluctuate in between the time you buy a bond and the time to its maturity date.

To determine the right mix between stocks and bonds, consider three scenarios: 80% stocks and 20% bonds, 50% stocks and 50% bonds, and lastly, 20% stocks and 80% bonds. Riskier, neutral, and conservative, respectively. Buy IVV, as mentioned above, for the stock portion and buy individual, high-quality bonds. It’s a good place to start.

Contact a Professional

If you don’t want to do it yourself, or if you have a more complicated personal situation to consider, you can always reach out to my firm via the website, or email info@archerbaycapital.com, or contact another fiduciary (also known as Registered Investment Advisors, or RIAs) to get advice.

Always ask what is the full, all-in cost and always understand the recommendation before investing. Advisors should be willing to work with you to create a financial plan for a flat fee or offer to manage the money for you on an on-going basis, also for a fee.

At Archer Bay Capital, we aim to take the mystery out of investing and help individuals learn what you need to know to become financially independent.  We will work with you to build your personal financial plan to ensure long-term financial health.  Contact us to learn more or to schedule a consultation today.

Congratulations on your current success and for taking care of your future!

[1] Don’t include the value of your home but do include the value of any investment property.
[2] $75,000 ÷ .05 = $1.5 million; $100,000 ÷ .05 = $2 million; $200,000 ÷ .05 = $4 million
[3] We use 5% because high quality bonds are yielding about 3% and we expect 7% returns from stocks over time. Blend the two and the midpoint is 5%. The most common standard used by endowments is 4%.
[4] Full disclosure: I do not get paid for referrals by Fidelity and I do not work for them. I do have my personal investment accounts and my clients’ accounts there.
[5] ETF stands for exchange traded fund. It is like a mutual fund but trades throughout the day rather than only at the end of the trading day.
[6] “Laddered” means having a staggered maturity of bonds, usually five or more bonds with maturities that range from 1 year up to 7 years. “Investment-grade” means high-quality bonds from companies with secure finances so they can pay you back when the bond is due. And “U.S.” because you don’t need foreign bonds.