RSU Stock Strategy: How to Avoid the Concentration Trap
Restricted stock units (RSUs) are a major feature of compensation packages that can dramatically enhance an annual salary, company bonuses, and other generous benefits offered by tech giants like Microsoft, Google, Amazon, and Meta.
But how does RSU stock factor into your investment portfolio?
The concentration trap ensnares many people without them even realizing it. If you hold excess stock in the company you work for, it exposes you to unnecessary financial and emotional risk, delays your financial independence, and costs you more than you think.
A strategic approach can help you extricate yourself from the concentration trap and help you pocket more of your hard-earned money. While a one-size-fits-all strategy rarely works, here are our best guidelines to help you think about your risk exposure and make wiser money moves with RSUs.
What is Risk, Really?
When we talk about risk, many people think of the stock concentration risk in their investment portfolio. The inherent cyclical nature of the stock market can create huge shifts in any portfolio, even a diversified one.
But when we talk about risk, we mean more than just the up and down swing of your RSU stock value. Risk can include heavy concentration in your company in other ways, too, such as:
Income Risk: Your monthly salary and annual bonus.
Career Risk: Your professional growth and industry reputation.
Equity Risk: Your largest investment asset.
For example, what about the well-being of your company? The amount of money you earn and take home ultimately depends on the company's financial success. While your monthly salary might appear set in stone, that’s not always the case. Raises or bonuses, usually granted annually, might be delayed if profits are down. If your salary sits still while inflation raises costs all around you, that can cascade down your entire financial plan.
The second risk is your career risk. Placing your professional eggs in one basket means that your professional growth hinges on the overall success of that company. Will you be able to move up the ladder to management and the C-suite at your current place of employment? Not to mention, industry reputation can be polished or tarnished depending on the company's association.
Last but not least, you have equity risk of holding RSUs in your investment portfolio. This is your largest investment asset and should be considered accordingly. Investments in company stock can be beneficial in some cases, especially when they are part of a robust compensation package. You might earn more through these RSUs than your annual salary and bonuses combined.
Of course, the convergence of these three risks poses a major threat. Financial advisors refer to such a situation as a Triple Threat.
What happens if your company hits a rough patch? The effects can echo in all three areas. A single corporate downturn can simultaneously freeze your raises, threaten your job security, and tank your net worth if the majority of your holdings are in company stock. Avoiding heavy concentration with your RSU stock is essential to insulate you from this potentially disastrous event.
“Sell to Cover” is Just the Beginning
When RSUs begin to vest, employees often arrange a sell-to-cover scenario. This allows them to sell just enough to pay for taxes at vesting. However, it is important to note that this clears up tax obligations and does not serve as a strategy to help offset risk and concentration.
In other words, selling to cover simply helps you avoid a large tax bill and potential fees. It can be a good thing, but there is room for a multi-layered strategy.
On the other hand, many employees think that holding RSUs “saves” on taxes. Unfortunately, this often just increases exposure to short-term capital gains (STCG) instead of long-term capital gains (LTCG).
Short-term capital gains taxes tend to be higher than those on long-term capital gains. These taxes are calculated based on whether the stock has earned or lost value since your initial investment. For RSUs, this is determined from the vesting date. If sold quickly, your gains are considered short-term and are subject to a higher tax rate. If you hold for a year and a day (or longer), LTCG features lower tax rates.
(Side note – your RSUs getting taxed twice means you also made money twice. It’s not always a bad thing! It’s just another aspect to consider as part of your larger plan.)
It might be worth asking yourself some hard questions when RSUs vest. Namely, would you buy these same stocks with cash from your bank account?
Many employees engage in creative mental accounting and treat their RSU funds differently from cash in their accounts. They might view these RSUs as a great opportunity – and sometimes, they can be. But if you would not have purchased the investment outright, this “mental accounting” could lead you to hold on to stocks you normally would not.
The Real Cost of the Concentration Trap
The concentration trap is a very real phenomenon that could lead to high costs for your future. Before the financial cost, consider the volatility drag associated with a single quarterly earnings call. When the CEO announces that profits are down, are you prepared for the inevitable swing in your net worth?
Everyone who maintains a large stock position in their RSUs will experience an emotional and financial toll in this all-too-common scenario. Picture a 20 to 30 percent swing in your net worth based on this one earnings call. This could also jeopardize your income with layoffs on top of the swing, all due to a single bad quarter.
After all, tech layoffs are common and sometimes even seasonal. The only logical thing to do is to plan appropriately so that your risk does not compound during a downturn.
When deciding how much concentration to keep in your investment portfolio, weigh the opportunity cost, too. Asset allocation matters when calculating long-term wealth. Instead of keeping your assets concentrated on one company, sector, or industry, consider what that money could be doing instead in a diversified index fund.
Not to mention, the concentration trap could delay your golden years indefinitely if you are not careful. Tethering your “Exit Number” to a single ticker symbol can add years to your career if the timing of a market dip aligns with your planned retirement.
After all, how much could you lose all in one fell swoop if company profits nosedive right before your retirement party?
Step-by-Step RSU Stock Exit Strategy
Does the concentration trap have you worried about your portfolio and financial future? While it’s beneficial to keep this in mind when RSUs vest, there are no hard-and-fast rules about how to handle your positions. Everyone’s specific strategy will depend on their unique situation and their level of concentration risk.
That said, we can provide a few general rules of thumb. While it’ll never be a one-size-fits-all strategy, our financial advisors can work with you to tailor a solution to your specific needs.
Step 1: Wealth Audit
Where do you hold the majority of your wealth? It might seem obvious to know where all your funds are tied up, but you’d be surprised how often this step gets skipped.
All you have to do is calculate what percentage of your total net worth (excluding your primary residence) is tied to your employer.
If the number is greater than 10 to 15 percent, you can consider that the Danger Zone. Your financial advisor may be able to recommend better investments to help you diversify and spread out the risk you take on, especially if retirement is on the horizon.
Step 2: Establish the Ceiling
After completing your wealth audit, pick a hard percentage cap. This is a line in the sand that you can always refer back to when faced with a tough decision. Anything above your ceiling will get sold immediately upon vesting, regardless of price.
This gives you more liquidity in your portfolio and allows you to invest in other assets that might be a better fit. In addition to eliminating some of the concentration traps, it also allows you to avoid some capital gains taxes by selling right away before they can appreciate in value.
Step 3: Same-Day Selling
We already talked about the mental accounting many employees will use to justify holding newly-vested RSUs. Now, we encourage you to view your RSUs differently. In reality, they are a lot like a cash bonus – and can be treated much the same way.
On the day that your RSUs vest, ask yourself this question: If the company gave you an equivalent value in cash right now, would you immediately use all of it to buy company stock?
This is typically enlightening for people who thought their RSUs were a great deal. If you answer this question with a resounding no, then selling some of your RSUs could be the smartest move for your financial future. Only a small percentage of people would invest this heavily in the same stock if given a cash bonus.
Step 4: Tax-Loss Harvesting and Tranches
Tax-loss harvesting can transform underperforming lots into more advantageous positions. No matter how savvy you are as an investor, you will eventually have some losers. Selling these positions can offset gains and help trim your overall tax liability.
The concept is simple: Sell your investments that have a gain and pocket the profit, but owe capital gains taxes on the proceeds. To offset that cost, sell an investment that has a net loss. The overall imbalance will cancel out some of those profits and reduce capital gains taxes.
If you have a particularly rough year, you can deduct up to $3,000 of losses against earned income. The remaining losses can be carried forward to future years, saving money during years when you are financially better off.
Step 5: Intentional Reinvestment
Just because you sell your RSU stocks does not mean that you should skip investing altogether. Use the proceeds from the sale of your RSUs to allocate funds to low-cost ETFs and other asset classes, such as real estate and bonds. Crucially, you should ensure that your new investments have zero correlation with your industry.
This allows you to spread out the risk, diversify your portfolio, and increase the likelihood that you will be able to weather a financial downturn.
Consult with Consilio to Avoid the Concentration Trap
The concentration trap is easy to fall into and hard to dig out of – unless you have a savvy team of financial advisors at your back.
Consilio Wealth Advisors is a fiduciary and wealth-planning group that specializes in working with tech professionals like you. Unique compensation structures, RSUs, annual bonuses, seasonal layoffs, concentration risk – we work through these obstacles with our clients on a daily basis, and we can help you too.
Don’t let just anyone review your situation. Trust the experts who navigate RSUs daily. Schedule a free consultation today to review your investments and learn more about how to protect yourself from common mishaps like the concentration trap!
DISCLOSURES:
The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.
The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.
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