{"id":492,"date":"2023-01-30T13:00:00","date_gmt":"2023-01-30T13:00:00","guid":{"rendered":"https:\/\/moneywithkatie.com\/the-risks-of-employee-stock-purchase-programs\/"},"modified":"2025-09-03T20:44:41","modified_gmt":"2025-09-03T20:44:41","slug":"the-risks-of-employee-stock-purchase-programs","status":"publish","type":"post","link":"https:\/\/moneywithkatie.com\/the-risks-of-employee-stock-purchase-programs\/","title":{"rendered":"The Risks of Employee Stock Purchase Programs"},"content":{"rendered":"
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Correction<\/em><\/strong>: An earlier version of this piece incorrectly stated you\u2019d pay short-term capital gains taxes on the spread between your discounted option price and the fair market value of the stock. It has been corrected below to clarify you\u2019d pay ordinary income tax, not short-term capital gains taxes (as you have no capital gains, if you flip the share immediately). Fortunately, for all practical intents and purposes, these are the same number (your marginal tax rate), lest my error. Depending on the way your plan is structured and the strike price you\u2019re offered, you may also owe short-term capital gains taxes as well on the spread.<\/em><\/p>\n<\/div>\n

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So your company is offering you discounted access to company stock. What do you do?<\/p>\n

(Pssst\u2026for our full deep dive on all things stock-based compensation, check out this week\u2019s episode of The Money with Katie Show<\/em><\/span><\/a>!)<\/p>\n

We only sprinkled a little<\/em> bit of podcast fairy dust on ye ole\u2019 Employee Stock Purchase Program (ESPPs) on the show this week, so I wanted to talk about my take on ESPPs in more #depth here.<\/p>\n

ESPPs are generally treated as part of your paycheck elections (that is, you can opt to buy discounted stock with your income instead of taking it as income).<\/p>\n<\/div>\n

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\n \u201c<\/span>There are effectively two ways to use your ESPP: One is like walking through the front door, and the other is like using the revolving door in the back.\u201d<\/span>\n <\/p><\/blockquote>\n<\/figure>\n
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Some employers will pay you with stock as part of your compensation package (and this becomes increasingly popular as you move up in a company), but we\u2019re not talking about receiving stock as compensation here\u2014we\u2019re talking about the option to buy it at a discount.<\/p>\n

It\u2019s important to consider the potential pitfalls of any investment decision, especially when it comes in the form of HR paperwork and well-intentioned Janice from payroll encouraging you to \u201cget that 10% discount on the stock!\u201d<\/p>\n

According to Human Capital<\/span><\/a>, 85.5% of information technology companies and 68.3% of healthcare companies in the S&P 500 offer ESPPs to their employees. In the Russell 3000, 67.7% of IT companies and 60.2% of healthcare companies provide ESPPs. In other words, if you work for a large public company, the chances are good you\u2019ll have some version of this option available to you\u2014but there are many different ways to structure such a perk.<\/p>\n

There are effectively two ways to use your ESPP: One is like walking through the front door, and the other is like using the revolving door in the back.<\/p>\n

First, let\u2019s break down the risks of \u201cwalking through the front door\u201d\u2014using the ESPP as a buy-and-hold strategy.<\/p>\n<\/div>\n

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The main risk? Compromising diversification of your investment portfolio<\/h2>\n

You know how I\u2019m always harping about how one of the best ways to protect yourself in down markets is to be properly diversified<\/span><\/a>?<\/p>\n

When you participate in an employee stock purchase program, you\u2019re trading diversification for cheaper access to a particular asset. Usually, the discount is somewhere between 5%\u201315%<\/span><\/a>.<\/p>\n

As we\u2019re all probably well aware by now, as a general rule, I don\u2019t believe in buying any<\/em> individual stocks as a major component of my investing strategy. <\/p>\n

A 2021 JP Morgan study<\/span><\/a> examining the loss probability of individual stocks found that 42% of stocks in the Russell 3000 had negative absolute returns between 1980 and 2020 and 66% trailed the index as a whole (which is a fancy way of saying, 6 in 10 individual stocks that made up the index actually underperformed the average<\/em> of the 10 overall). All that to say: You have worse than a coin flip\u2019s chance in working for a company with a stock that beats the index over the long run.<\/p>\n

And while it\u2019s certainly possible, it\u2019s\u2014statistically speaking\u2014not overly likely in the long term.<\/p>\n

Now, I always used to caveat this speech by saying, \u201cThat is, unless you work for, like, Facebook!\u201d<\/p>\n

\u2026except for the fact that\u2014this year\u2014the stock\u2019s meteoric gains were almost totally wiped out after the company placed a huge bet on the metaverse, and was down 65% by the end of the year. <\/p>\n<\/div>\n

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\n \u201c<\/span>Owning too much of any one company isn\u2019t the safest plan if your investing strategy is intended to carry you through the next few decades.\u201d<\/span>\n <\/p><\/blockquote>\n<\/figure>\n
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The other issue at hand? If you work for one of the biggest tech companies and own a bunch of S&P 500 or Total Stock Market index funds, you already own a disproportionate amount of your own company\u2019s stock. Apple alone comprises 6.3%<\/span><\/a> of the S&P 500 index fund.<\/p>\n

And while you can make the case that Apple and Google are going to continue their climb to world domination, if history is any indication, most big companies are eventually usurped. Owning too much of any one company\u2014no matter how dominant it seems today\u2014isn\u2019t the safest plan if your investing strategy is intended to carry you through the next few decades.<\/p>\n

One counterargument I\u2019ve often heard is, \u201cBut if I\u2019m working for this company and have an impact every single day on its success, isn\u2019t that worth betting on?\u201d<\/p>\n

\u2026and I think that point stands if you work in a four-person startup.<\/p>\n

If you\u2019re working for a company that\u2019s already large enough to be publicly traded, it\u2019s unlikely that your contributions as one individual are going to have any real bearing on what the stock price does or the long-term success or failure of the company (unless you\u2019re the CEO or another exec; in which case, would you like to sponsor Money with Katie?).<\/p>\n

There\u2019s one other<\/em> risk associated with holding too much of your company stock:<\/p>\n<\/div>\n

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The secondary risk: Your income and<\/em> investments are tied up in one company\u2019s success<\/h2>\n

While this doesn\u2019t really apply if your company stock accounts for a tiny fraction of your total portfolio (which may be a bet you\u2019re willing to make), if you\u2019re primarily<\/em> investing in company stock and taking your paycheck from that same company, you\u2019re relying on the same hen for all your financial eggs. (How\u2019s that for a twist on the \u201ceggs in one basket\u201d analogy?)<\/p>\n

The same point goes for the big tech employees\u2014your company is already disproportionately represented in your index funds, so you\u2019re placing an even bigger bet when you load up on more.<\/p>\n<\/div>\n

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\n \u201c<\/span>After all, \u2018diversification\u2019 means owning assets that aren\u2019t perfectly correlated.\u201d<\/span>\n <\/p><\/blockquote>\n<\/figure>\n
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After all, \u201cdiversification\u201d means owning assets that aren\u2019t perfectly correlated\u2014and it doesn\u2019t get much more correlated than big tech and the S&P 500.<\/p>\n

If something happens to your company, not only do you lose your paycheck, but that portion of your portfolio suffers, too. (Enron employees have entered the chat.)<\/p>\n

Regardless of who you work for or how great they seem, that risk may not be worth taking.<\/p>\n

Of course, most people who use an employee stock purchase program aren\u2019t only<\/em> investing in their own company stock\u2014but I\u2019ve definitely seen young new hires sign up for the program in an attempt to be a well-intentioned Budding Adult\u2122 and not bother to invest anywhere else.<\/p>\n

In that way, their entire financial future is tied up in the success or failure of one company. It\u2019s too risky.<\/p>\n

But what about using the revolving side door? That\u2019s another story.<\/p>\n<\/div>\n

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How to hack your ESPP for a guaranteed return<\/h2>\n

All of that proselytizing out of the way: Depending on how your<\/em> ESPP is structured, it might<\/em> be a way to get some guaranteed returns on your money. <\/p>\n

Let\u2019s take a walk down benefits planning lane, shall we? If your plan\u2026<\/p>\n