Employee Stock Purchase Program

[mrgrump]

In approximately a week I will be starting a new job that offers an ESPP. The program allows employees to purchase stock at a 5% discount. An amount I select is withheld from each paycheck and used to purchase stock at the close of each quarter.

Once the new job starts the wife and I will be maxing out 2 401ks and a 529 plan. So the stock purchase isn't are only savings and we just refinanced to a 3.375% 15 year mortgage so the return on the stock would be slightly better.

With that being said...

Should I sell the stocks as soon I acquire them and capture the 5% profit, buy and hold, or ignore the program altogether and funnel the money in our index funds.

[electriceagle]

The 5% discount gives you a semi-guaranteed (it could go down in the 2-3 days between when it is granted and when it appears in your account) 5.2% rate of return.

Typically, these programs are run semi-annually, so thats a 10%+ annualized return (I really should calculate from the half-period mark; that would push it higher).

Also, ESPPs generally give you a discount from the lower of the stock price at the start of the period and the stock price at the end of the period. Assuming that the stock has a 50/50 chance of going up or down, you have a 50/50 chance of getting a 10%+ annual return or a 10%+++ annual return.

I suggest maxing out the ESPP and selling the stock as soon as it becomes available.

There is some risk in selling the stock as soon as you get it: it may skyrocket, leaving you the only person in your office who isn't filthy rich. On the other hand, you're avoiding the risk that your company will be the next Enron, as well as the correlated risks that something will happen to the company that causes the stock to fall and you to be laid off.

[Prairie Stash]

Max out the purchases and sell. Get the 5% profit and consider it a bonus.

Google Enron and read about the employees who lost their jobs and all their retirement savings at the same time. Learn from their pain.

[Breck]

I understand the sentiment against having too many eggs in one basket by tying some of your investment money to your job, but my personal strategy has been to hold for the qualifying disposition. 

With only a 5% discount, the risk (possible drop in 2 years) my not be worth the reward (ordinary inc tax vs LTCG tax). I think understanding your industry and your company are key factors to consider when making the decision.

Also, what percentage of your salary do they allow you to buy? Mine is 10% (2.5% per quarter).

[shuffler]

My personal strategy has been to hold for the qualifying disposition. 

With only a 5% discount, the risk (possible drop in 2 years) my not be worth the reward (ordinary inc tax vs LTCG tax).

The link you gave has 3 examples, all of which show the employee paying ordinary income tax on the ESPP discount (unless the stock went down).  I don't see much/any "reward" here.

(FWIW, there was a thread on this not too long ago.  http://forum.mrmoneymustache.com/investor-alley/employee-stock-purchase-program/)

[msilenus]

The RoR that the 5% discount represents is much more than 5% per year.  It's better the shorter the offering period is.  If it's 2 years, then it's 5%.  If it's 6 months then it's more like 20%.  Guaranteed 20% RoR?  Yes, please.

Sell right away.  The favorable tax treatment on qualifying dispositions is of extremely marginal value.  The discount is taxed as ordinary income on your W-2 --not as capital gains.  (Unless you screw up and pay both, which is pretty common.  More on that below.)  The tax benefit of holding is that you defer paying taxes on the discount-income until you sell, and if the stock drops before you sell I think you can deduct it out that income instead of having to treat that part as a capital loss --that latter bit is what you get out of a qualifying disposition.  Those tiny advantages are simply not worth tying up 20x that much money for.

Some custodians don't report the cost basis on your sold shares correctly.  They report the purchase price, rather than the trade price.  Why is this wrong?  Because the discount was reported on your W-2 and taxed already as ordinary income.  Not all custodians screw this up.  It should be obvious on your first purchase which kind you have.  Check for it, and adjust your cost basis at tax time if necessary.

[gimp]

We've had this discussion before, with the conclusion that you definitely want to get in on the ESPP, and you want to sell as soon as you can.

[mrgrump]

Breck - I am not sure of the limitation. It wasn't spelled out in the benefits handbook they gave me.

Shuffler - thanks for posting the link.

The companies stock is up about 40% over the last year so the company is doing well and the balance sheet reflects this.

I am going to participate I just haven't decided to what level or strategy. I am leaning towards buying a small amount and holding but I do understand and I am considering the buy/sell strategy as well.

[Thegoblinchief]

No sale restriction?

Is it a stock you'd consider holding anyways? (Does it pay a stable and/or growing dividend?)

If the answer to both is yes, then consider it given all of the other savings you have. But 5% discount isn't much at all for a ESPP.

[JCfire]

In approximately a week I will be starting a new job that offers an ESPP. The program allows employees to purchase stock at a 5% discount. An amount I select is withheld from each paycheck and used to purchase stock at the close of each quarter.

Once the new job starts the wife and I will be maxing out 2 401ks and a 529 plan. So the stock purchase isn't are only savings and we just refinanced to a 3.375% 15 year mortgage so the return on the stock would be slightly better.

With that being said...

Should I sell the stocks as soon I acquire them and capture the 5% profit, buy and hold, or ignore the program altogether and funnel the money in our index funds.

I would either sell the stock as soon as I had the ability to do so after the initial lock-up period (do your homework on that first), or ignore the program altogether.  Do not buy and hold under any circumstances.  Ask the employees of Lehman Brothers, Bear Stearns, Enron etc how it felt to lose their job and a big chunk of their life savings all at the same time.  There are thousands of people who were FI and still employed at one of those places one day, and almost overnight found themselves unemployed and 10+ years from FI.  Your future income stream from your employment is one of the biggest parts of your personal portfolio and it has significant risk exposure to your employer -- common sense diversification suggests you don't need to double down on that risk in other parts of your portfolio.

[Donovan]

I have an ESPP with the same discount (5%) that gets paid out every quarter.  I'm not in right now because of other obligations on a single income, but as soon as my wife starts working next year we intend to buy/immediately sell the max I can every quarter ($4000/month).

In general, I think it's fantastic to have the guaranteed return. However, do your research on the exact terms of the program. Mine, sadly, is run through E-Trade which is charging $20/trade when I cash out, which eats some of my profit from the discount at the maximum contribution (and an even greater percentage if I don't max it out).  It changes the math to benefit an all-in approach, but it's still a greatly beneficial program to effectively increase your salary by a decent amount (max ~$2000/year under my plan, YMMV).

[desrever]

What is the 5% discount on? Is it on the FMV on the purchase date, or of the smallest price on a few historical dates? For the ESPP I had at an old employer, the real benefit was not the percentage discount but the fact that you could be buying at the lowest price from up to two years prior. At its peak I was tripling my contributions (the max was 10% of my salary) thanks to a very volatile share price.

I think you should err on the side of maxing out the ESPP, and closing your position ASAP. For the plans I've seen this is free money with very little downside risk. Hopefully the employer provides some education on how the ESPP works; you will need to find out ALL of the following to make the right decision: how the purchase price is calculated, what the max contribution is, how frequently the purchases occur, how soon your shares are delivered to you after the purchase date, whether you'll be subject to a trading blackout window, whether the purchase date will ever fall in a scheduled blackout period, how much it costs to sell.

[msilenus]

I have an ESPP with the same discount (5%) that gets paid out every quarter.  I'm not in right now because of other obligations on a single income, but as soon as my wife starts working next year we intend to buy/immediately sell the max I can every quarter ($4000/month).

This strikes me as backwards.  It seems like the less income you have, the more you should be fighting for free money.  It's much more marginally impactful.

Do you have an emergency fund?  If you maxed your ESPP, could you make up the shortfall out of savings for 3 months then start using 95% of your ESPP payouts for living expenses and pocket the rest?

[econberkeley]

My company gives no discount for ESSPP purchases. HR told me you don't have to pay for brokerage fees:) I am not joking. She was serious.

[NewPerspective]

My husband has a similar plan.  (His is a 7% discount).  We basically hold it for a year to avoid short term capital gains and then sell it.  In the past we have used some of the proceeds to do house stuff, but now we have gotten smart.  It is all going to investments.

He works for a very large, stable company that has been around for a long time.  There is some risk in holding for a year (like an Enron situation) but we have other savings and feel the risk is worth it for us to avoid short term capital gains taxes.

[surfhb]

I've always held the notion that smart investing is diversification.   Since you're already invested in the company by working there, I'd pass it up and just invest in a total market index.   

There is usually a restriction to sell on these programs anyway

[gimp]

My company gives no discount for ESSPP purchases. HR told me you don't have to pay for brokerage fees:) I am not joking. She was serious.

Ooooooooooh, no brokerage fees. You mean you don't have to pay $2 to buy a bunch of stock? How generous.

Christ.

The math for waiting out the short-term capital gains period only works out if your company at the very least just slightly underperforms your favorite index, or matches it, or exceeds it. Otherwise you've lost money: you could have sold, taken the tax hit, and invested in your favorite index fund.

If the choices are, roughly: lose a lot, lose a little, stay flat, gain a little, or gain a lot - you need it to gain a lot (if you define "a lot" as I have) to make money.

Considering how much stock prices fluctuate, often for no good reason - selling asap is generally the way to go. Otherwise, it's gambling. Nothing wrong with gambling.

One strategy that I've seen people do is that they hold it, but auto-sell if the stock drops below index performance. Which is a fairly complicated thing you need to keep track of and re-evaluate often. If  you put time into that, it's a pretty good strategy; you're guaranteed not to lose money. Only worth putting time into that if you think the stock is going to track upwards a lot.

[ljp555]

I get a 15% discount, looking back 2 years. I use ESPP as a risk-free investment; the risk of holding the stock for a year is too great for me despite the tax benefits (this is a controversial subject among my co-workers!).

Here's my reasoning (I used your 5% discount in the calculation).
Say I contribute $10k/year.
Stock's market value is $25, so purchase price is $23.75 ($25*.95), which buys 421 shares ($10,000/23.75)
421 shares are worth $10,526 ($25*421), so you have a short term gain of $526
Probably your marginal tax rate is lower than mine, but I pay 45.1% (28% federal, 9.3% state, 7.8% payroll), so short term capital gains comes to $237. After tax free money of $289, yay!

Assume you hold for 1 year, so you get long term capital gains treatment. For me, this gives a marginal rate of 24.3% (15% federal, 9.3% state). If the stock price stays the same, I would pay just $128 in tax, saving $109.

HOWEVER, that whole year I would have the $10,526 invested in my companies stock. So if the stock price dips to $20 (an equivalent drop has happened in the past year at my company), then my 421 shares are only worth $8421. Add in tax benefit $384 for taking the loss, then I have a loss of $1195 ($8421-10,000+384). It doesn't take an Enron-style catastrophe to completely wipe out the ESPP gain and some of the principal investment.

For me, saving $109 is not worth putting the entire $10k at risk. Though it depends on your investment strategy as well. Personally I don't invest in individual stocks (in my company or otherwise), so holding any individual stock for a year runs counter to my diversification plan. And the tax benefits are too small for me to do that.

[mrgrump]

The buy and immediately sell plan seems to be the consensus. But I have done a little more digging and come up with more information.

The ESPP is ran by e-trade but does not offer any look back period. The purchase price is just 5% lower than the stock price on the last day of the offering period. I have been unable to find any information on blackout, holding restrictions or contribution limits.

The company is fairly stable and ranks in the top 50 of the Fortune 500 (moved up 9 spots since 2013).

Paying $20 to sell off the stock might kill off my strategy for investing just a little at a time if my costs are the same as one poster mentioned.

But in even better news I found out the 401k plan is through Vanguard!

[surfhb]

The buy and immediately sell plan seems to be the consensus.

I dont believe ESPPs let you do that.  :)     If its an S&P 500 company and you're investing in low cost index funds (as you should) then you are over lapping your investments.   

Skip the ESPP I say

[RapmasterD]

We've had this discussion before, with the conclusion that you definitely want to get in on the ESPP, and you want to sell as soon as you can.

+1 -- Make sure your company has a QUICK SELL option.

[clifp]

I think people are forget a key thing about the ESPP, almost all plans let you buy at the discount of between (0-15%) at the lower price of the beginning or ending period.  Which is typically 6 months but can be as long as 2 years.  During that period the stock generally moves up, and sometime it can move up considerable you can lock in the capital gains treatment for not only the discount but the price move.

So for instance my old company, Intel stock after languishing for years in the 20-25 range went up $31.50 in the last few months. Using the $10K figure for a high earner in the 33% bracket. The purchase price would be $25-3.75= $21.75  giving you ~460 shares which is $4573 in profits. The federal tax saving would $823 and state taxes could push the saving to $1,000.   Keeping the stock for an additional 18 months provides pretty significant savings.  Yes there is some diversification risk, but I am not sure for somebody making $200K a year there is that much risk in holding $15K worth of company stock.  Remember on average stock prices do go up so your tax savings will generally be higher.

In most scenario where the is little price appreciation beyond the discount than certainly sell and take the profit, but I don't think it should be an automatic decision.

[gimp]

Hey clif, where at Intel? I used to work at Hudson, then Santa Clara, then Hillsboro. Post-silicon debug on Poulson/Ivytown/Haswell and microcode on Knights Corner. Their ESPP is pretty great. To be fair, it's fairly standard for silicon valley.

[RapmasterD]

The buy and immediately sell plan seems to be the consensus.

I dont believe ESPPs let you do that.  :)     If its an S&P 500 company and you're investing in low cost index funds (as you should) then you are over lapping your investments.   

Skip the ESPP I say

FYI that most plans not only let you do this, they automate it for you so you can set it and forget it. My wife and I both use the quick sale option at our respective employers.

[surfhb]

The buy and immediately sell plan seems to be the consensus.

I dont believe ESPPs let you do that.  :)     If its an S&P 500 company and you're investing in low cost index funds (as you should) then you are over lapping your investments.   

Skip the ESPP I say

FYI that most plans not only let you do this, they automate it for you so you can set it and forget it. My wife and I both use the quick sale option at our respective employers.

Really?    Ours restricts us to a year.    Id purchase with my entire paycheck everything month if that was case 

[Breck]

My personal strategy has been to hold for the qualifying disposition. 

With only a 5% discount, the risk (possible drop in 2 years) my not be worth the reward (ordinary inc tax vs LTCG tax).

The link you gave has 3 examples, all of which show the employee paying ordinary income tax on the ESPP discount (unless the stock went down).  I don't see much/any "reward" here.

(FWIW, there was a thread on this not too long ago.  http://forum.mrmoneymustache.com/investor-alley/employee-stock-purchase-program/)

I stand corrected. The price discount offered will always be taxed as ordinary income. Looks like I need to re-evaluate my strategy...

[defenestrate]

Take the free 5% discount at the maximum you can handle.
Sell the stock for the lowest transaction cost
Purchase an index fund with the proceeds--