You are such a tough crowd. Friday, I responded to one of you who was considering participating in his company’s Employee Stock Purchase Plan. His wife thought he shouldn’t do it. But like many such plans, this one offered two incredible things — hindsight (by allowing him to purchase shares in his company’s stock at the lower of the current price or the price six months earlier); and free money (by giving him yet a further 15% discount off that price). In other words, worst case, he’d have an instant 15% gain on the shares.
“So, what do you think?” he asked me. “Am I better off staying out of the plan as my wife thinks or am I stupid not to be investing to the hilt, as my co-workers say?”
“Well, I wouldn’t use the word stupid,” I replied, not wishing to offend. “But it does sound like a very good deal.”
Several of you thought I was being much too polite.
Well, I’d use the word “stupid.”
You hit a pet peeve: people who don’t enroll in their ESPP programs because they think they can’t afford it.
The plan that your correspondent describes is pretty typical for those of us that work in the high tech field. Consider the ROI [return on investment] of investing in the aforementioned ESPP. He gets a 15% discount. Ok, so his ROI is 15%. No, wait. He only had the money tied up for six months, so the ROI is 30%. No, wait. He started out with no money invested and in a linear progression invested the full amount over those six months. On average, he only had half of the money invested for those six months, so the ROI on his investment is really 60%!! [No wait. If you do it on an annualized basis using the IRR function of your calculator or Excel spreadsheet, it comes to more like 93%.] What other investment guarantees you 60% [let alone 93%] ROI with no risk??
If he’s concerned about the market volatility, he can always short the shares on the day the ESPP period ends (assuming that he has a margin account) and then deliver up the shares to close the position when he actually gets them.
If liquidity is the issue, he should take note that one is better off borrowing against a credit card at 21.5% and enrolling in the ESPP program rather than not participating in the program!!
If his concern is brokerage fees, then open an Ameritrade account and pay the $8.
Furthermore, if he holds the shares for 1 year after their receipt and 2 years from the enrollment date for the ESPP, then they qualify for long-term capital gains treatment and only the 15% discount is taxed at the ordinary rate. You may even be able to get away with deferring the payment of taxes on that 15% discount until you sell, depending upon the position that your employer takes with the IRS. (They, being the IRS, argue that the tax is due now. Some high-tech employers argue that is not the case.)
Oh yeah, and don’t forget the considerable upside possibility that Sun Microsystems stock may continue to skyrocket during those 6 months [so the 15% guaranteed gain — which is really a 93% rate of return — might actually be a great deal higher]. How else can you invest in a tech stock without personally assuming any risk of loss?
Just sign up.
Brian Holdren explains very clearly how that minimum 15% turns out to be 93%:
I use the following example to try to persuade people that it is foolish not to participate in these plans. [Ah — foolish! That’s a lot less offensive than stupid. Brian is a diplomat after my own heart.] Assume you contribute $100 per pay period (twice a month in this example). At the end of 6 months you have put in $1200. You get a 15% discount on the stock when you buy it, so you’re able to buy $1411.76 worth of stock for only $1200. (This assumes that the stock price has not risen over the 6-month period.) But, not all of your $1200 dollars has been tied up for the full 6 months. In fact, less than half of it has been. Try to figure out what interest rate you’d need from your local bank to turn those $100 twice-monthly deposits into $1411.76 after only 6 months. Input the 12 biweekly payments into Excel, and it will tell you: 93%. The annualized return comes from Excel’s XIRR function (Internal Rate of Return).
Of course, not all plans are equally good, so it’s important to understand the rules . . .
Clint Chaplin: “I had to interject something: Some companies will not allow you to flip the stock when you purchase it; they require a six month holding period, in which time the stock could go south on you.”
And not everyone is enamoured with them . . .
Toby G: “I have had experience with these also. I was in one for several years and eventually came out of it just about even. That came from holding on to the shares. I then swore off of such plans for life. [I have withheld Toby’s last name here in order to be able to say it’s really . . . foolish . . . to swear off these plans, let alone swear them off for life.] A more important point about your article today: a company I worked for recently also had such a plan. But their policy was that employees were not permitted to short the stock or to trade in options at all. So, if you were in the plan you were vulnerable to short-term losses if they occurred when you were buying shares. And it did happen, and not just in October 1987. They did make one adjustment to ease this, though: they moved the plan dates to mid-quarter instead of coinciding with the ends of the 2nd and 4th quarters, since the greatest volatility occurred in association with reporting quarterly results.”
Plans do differ . . .
David D’Antonio: “I read your comment today about Employee Stock Purchase Plans and I was rather taken aback that it took this person 2-3 WEEKS to get his shares. The company I work for has about a 2-3 DAY delay due to much of the work being done by hand. But I still could sell on the day the shares were posted to the account.”
David goes on to make a separate point: “There is another way to get burned, as some people have here. Namely: black-out periods [during which you are not allowed to buy or sell shares]. The ESPP buy dates used to coincide with a company-wide black-out due to earnings announcements. When the black-out period expired, the stock was often lower than the buy price. But that’s been fixed by shifting the ESPP buy dates. And then they removed the black-out period for all employees under the Director level so it’s doubly moot for most of us.”
But by and large, as I tried to suggest Friday, Employee Stock Purchase Plans are generally a very good deal. Let’s give the last word to ddg (who prefers to be identified only by his initials):
Uh, oh, Andy you blew it today. Your advice was below par, not what I expect from you.
His company is offering him 17.6% free!
[If you get $100 of stock for $85, you’re getting a 15% discount. But your $85 has instantly appreciated 17.6%. And as noted above, the actual internal rate of return comes to more like 93%. And all this presupposes that the stock has not risen during the six-month period. The actual discount could be much higher than 15%.]
Should he take the free money? The answer is: It is stupid not to. [Stupid! Cretin-like! Dumb as mud!]
The deeper question is: should he sell the shares immediately? His wife’s complaint that he “has no money to invest” is inexcusable [inexcusably stupid!]. If he has a steady income, he must set aside a portion to invest, and you should have emphasized that. It will never be easier to start in the future. The part that gets easier is the amount, not the initial habit.
So my advice would have been to squeeze your finances for whatever you can. Eat hotdogs, or rice and beans, or maybe even fast one day a week. Whatever. Start payroll deducting as much of the $4000 as you can. If you can’t do it all this year, add 50% of your next raise, and 50% of the next one until you do get to the “hilt.” (Like I said, it does get easier.)
When you get the shares, you will pay taxes on the 15% company contribution, but you won’t have brokerage fees unless you sell. If you absolutely must have some of the money back, then sell what you must. But just as you squeezed to get the shares, you should hold them, too. As long as you believe in your company’s growth, then you should take the opportunity to own part of it. If you don’t believe your company is worth investing money in, then you have a bigger problem — you shouldn’t want to invest your time there either.
[DDG may be getting a little carried away here. It’s not easy to hop jobs every time you think your company stock is overvalued, or less attractive than others. And you already have a huge egg in the company basket — your livelihood. Think twice before putting too large a portion of your net worth in the same basket.]
Brian must form these habits now.
I’ve “been there, done that,” and over my wife’s initial objections, too. She’s a lot more comfortable with it now, particularly since the investment is worth 8 times my total contribution.
Please use only my initials if you print this. — David D. Godfrey
Needless to say, all this works better when stocks are generally rising than falling. But over the very long run, stocks generally do rise. And, in any event, if your plan allows you to lock in your 17.6% profit instantly, with no risk of loss, it’s stupid not to take advantage of it. There. I said it.
(Needless to say, also, I’m kidding about David D. Godfrey. Ddg’s real name is . . . well, I can’t tell you.)
Quote of the Day
Sarchasm: The gulf between the author of sarcastic wit and the person who doesn't get it.~A winning entry in the Washington Post Style Section Invitational
Request email delivery
- Apr 13:
Justice, Music — And Wow!
- Apr 12:
An App You’ll Want To Check Out
- Apr 9:
Demented Agents; Brain HQ
- Apr 8:
Barney’s Excellent Advice
- Apr 7:
The Latest From Mystic Mag
- Apr 6:
Boehner And More
- Apr 5:
The Details Can Be A Little Challenging To Work Out, But . . .
- Apr 2:
Fixing Our Infrastructure . . . And Our Soul
- Apr 1:
Fun And Fraud
- Mar 31:
How’s Your Elevator Pitch?
- Apr 13: