Surely, I’m better off investing in my employer’s shares
Many employees hold shares (and/or rights to buy shares) in their share market listed company employer. The interest may have been acquired as part of their remuneration package or as compensation for sale of a business to the employer. Or, perhaps, the employee was optimistic about the prospects for the employer and bought its shares as an investment.
Often, there are restrictions imposed on dealing in the shares, at least for a specified period after acquisition, so the employee has no alternative but to retain the position. However, even when there are no restrictions, many employees continue to hold and, over time, build substantial (but minority) interests in their employer.
There are a number of reasons that may explain this behavior. One is that the employee simply fails to manage the position, effectively putting the shares in the “bottom drawer” hoping they will accumulate into a nice little nest egg.
Often, it is because the employee believes they are taking a stake in a business that they know intimately, are comfortable with and believe their presence will enhance the company’s performance. They also may have the view that if things go wrong, since they are on the “inside”, they will be able to get out early.
And, finally, there may be significant tax payable if the shares have done well and are sold. Why would you sell high performing shares to buy something that may not do so well and create a serious tax liability for yourself?
There is no doubt that many employees have accumulated significant wealth from receiving and holding shares in their employer beyond any minimum restraint periods. However, there are probably many more that have seen their financial futures jeopardised or even ruined by such a practice.
Too many eggs in one basket …
We think that voluntarily holding a substantial part of your investment wealth in your employer is, generally, not smart wealth management practice.
The psychology that attracts many employees to owning significant holdings of their employer’s shares is similar to that which attracts people to purchase investment property, usually in a location they know well. The familiarity factor provides comfort and a sense of control. But the control is largely illusory.
While an employee may know a lot about their employer’s company and its prospects, it is unlikely that they will know more than the market wisdom that collectively determines the company’s current share price. However, it is what you don’t know that is likely to catch you out. Taking a large bet on a single share offers the chance to make you very wealthy or, perhaps, much poorer. At any point in time, you have no idea what the outcome will be.
But, the reality is that individual shares are considerably more risky than the overall share market. They carry specific industry and company risk that is diversified away at the total market level. Modern portfolio theory explains that you cannot expect to be compensated for such diversifiable risk. While the opportunity to earn higher expected returns always requires taking higher risk, unfortunately it does not follow that the higher risk of individual shares should result in higher returns.
Individual shares do offer the small chance of doing much better than the market. But it is more likely they will do worse and, perhaps, considerably worse. In fact, unlike the total market, individual companies regularly go out of existence. Witness, Allco, Babcock & Brown, ABC Learning, Lehman Brothers etc. Their employees generally didn’t see the total demise coming until it was too late.
So the concentration risk associated with a large share holding in your employer doesn’t make good wealth management sense to us. But to add to the problem, you may also put in jeopardy what may be your most valuable asset – your future earnings potential. It is not unusual that when a company and its industry faces financial difficulties, often simultaneously, employees lose their jobs or, at least, expected career progression slows.
So, there is a potential double whammy. At the same time as your investment wealth declines due to a fall in your employer company’s share price, the value of your human wealth or projected surplus capital also falls. So closely aligning your investment wealth with your human wealth is a risk that’s just not worth taking, if it can be avoided.
Reduce your exposure to your employer
It is difficult to reduce the exposure of your human capital to your employer. But, given that, sensible wealth management that is focused on protecting and nurturing rather than maximising (and potentially destroying) wealth dictates minimising exposure to your employer company’s share price.
It also suggests the need to:
- develop a personal financial plan that aims to make your financial future as independent of the fortunes of your employer as is realistically possible, as soon as possible; and
- implement an investment strategy that takes account of and seeks to offset the significant additional risk implied by a large concentrated share holding.
And, you should know exactly how you are going to reduce your exposure, once any restrictions on dealing in your company share holdings are removed. Of course, tax consequences will need to taken into account, but they are unlikely to be an overriding consideration.