Diversifying Your Portfolio Post-IPO

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In our post about what Twitter employees need to know after the IPO, we highlighted that diversification is the single most important objective for most investors.  Why?  Because diversification means greater return with less risk.  That’s the “Holy Grail” of investing, as we’ve once written (see our post about the Facebook IPO).

And never does the adage about not having too many eggs in one basket hold true more than after your company’s initial public offering.  “No matter how bullish you are on the stock, you need to get some of that money off the table,” says Paul Bergholm, our Chief Financial Officer.

In the following post, we’ve gathered answers to some of our most frequently asked questions about the IPO process and managing your wealth.

Question: What are the risks of keeping most or all of my stock shares?

Answer: If you’ve just completed an IPO, there’s a good chance that your company stock makes up a significant portion of your portfolio. While it may be tempting to hold onto your shares, there are three key risks in adopting that strategy.

First: single stock concentration risk.  At this point, both your employment and stock shares are highly vulnerable to a hit to your company. Individual stocks tend to have highly unpredictable prices and no guarantee of any return.  The difference between the annual high and low of a typical stock price traded on the New York Stock Exchange is nearly 40%[1] – in investment terms, equities are highly volatile.

Second sector risk.  If your existing portfolio strategy has general market exposure, odds are that you may already be overexposed to the tech sector – without the addition of your new stock. Because indexes such as the S&P500 are what’s called “cap weighted,” as sector valuations increase, so too will their impact on your portfolio.  Currently, tech represents nearly 18% of the S&P.  The danger is that market “bubbles” and “bursts” tend to happen by sector (to see how you can remedy this in your portfolio, see our tactical weighting approach).

And finally, IPO stock risk.  According to studies by University of Florida Professor of Finance and IPO expert Jay Ritter, since 1970, new IPOs have underperformed the market by an average of 6.5% per year over their first two years.

Selling some of that company stock will help diversify your assets, and ensure that a sudden drop in the stock price doesn’t decimate the wealth you’ve worked so hard to earn.

Question: When should I begin to think about selling off my stock shares?

Answer: You’ll want to start crafting a sell down plan right away. However, keep in mind that you won’t be able to immediately execute it.

Following an IPO, your stock is likely in a lockup period, which prohibits you from selling any of your shares for a specific duration, usually 90 to 180 days.  Keep your eye out for any other restrictions that are stipulated in your equity compensation agreement; even after the lockup expires, you may be subject to additional blackout periods.

“You need to first understand ground rules,” says Paul. “Then you can plan.”

Question: How should I time my sell down?

Answer: There are many different strategies for selling stock shares following an IPO. For example, you might sell all of your shares immediately or meter out the sales by shedding 10% of them from your portfolio each quarter for 10 quarters.

The strategy that works for you will depend on myriad of factors including your financial goals and potential tax liability. However, regardless of the timing, the key is to strategically reduce your equity stake in an automatic fashion that takes the emotion out of the decision to sell.

“Employees are often perpetually bullish on their company,” counsels Paul. “But no matter what happens, it’s imperative to make a sell plan. You have to say this is the rule and I’m selling regardless of what’s happening with the share price.”

Question: What are some important, strategic considerations for a sell-down plan?

Answer: “Your financial well-being is the first priority,” according to Paul. You first need to take stock of your current financial picture. For example, do you have any credit card debt? Are you on track with your retirement planning?

Then identify your financial goals, perhaps buying a new home, paying off the one you have or saving for your children’s college education. Those goals will help set the parameters for how your sell down plan contributes to your overall financial strategy.

When deciding how much to sell down, keep in mind that even if you sell all of your existing shares, you’ll continue to have exposure to your company’s potential growth.   How?  Through your salary, further vesting of options and more option grants.

Question: How should I account for taxes?

Answer: While taking that money off the table is the priority, you still need to be smart about taxes and be aware of how the form of your equity compensation impacts your tax situation.

Restricted Stock Units (RSUs), one of the most common forms of equity granted to employees, are taxed as regular income. If you have RSUs, you’ll report the fair market value of the shares on the date they vest as income for that year. Once the RSUs vest, the added income may bump you up an income tax bracket. Some investors sell stock specifically to cover their tax bill.

Other types of stock options have different tax ramifications. And once you sell your shares you’ll also be subject to taxes on the gains.

Tax and estate planning often go hand-in-hand, with the latter providing options, including various trust strategies, for minimizing your tax liability. If you’re so inclined, a charitable giving plan can also provide deductions to help offset the taxes incurred by your newfound wealth.

Question: How can Personal Capital help me post-IPO?

Answer: First, our free software helps you to see how your options fit into your entire financial picture.  Check out the details about how to use our Stock Option Tracker on the Personal Capital Dashboard.  Further, Personal Capital users who aggregate post-IPO equity may qualify for a free consultation with a Personal Capital advisor.  Our advisors will work to help you identify priorities and potential pitfalls and, of course, create and execute a plan that works specifically for your situation. Read more about investing with Personal Capital here.

 


[1] 2006 Morningstar study.

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Disclaimer. This communication and all data are for informational purposes only and do not constitute a recommendation to buy or sell securities. You should not rely on this information as the primary basis of your investment, financial, or tax planning decisions. You should consult your legal or tax professional regarding your specific situation. Third party data is obtained from sources believed to be reliable. However, PCAC cannot guarantee that data's currency, accuracy, timeliness, completeness or fitness for any particular purpose. Certain sections of this commentary may contain forward-looking statements that are based on our reasonable expectations, estimate, projections and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not a guarantee of future return, nor is it necessarily indicative of future performance. Keep in mind investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money.