STRATEGIES FOR FAMILIES WORTH $5 MILLION TO $500 MILLION
The insights you’ll discover from our published book will help you integrate a variety of wealth management tools with financial planning, providing guidance for your future security alongside complex financial strategies, so your human and financial capital will both flourish.
Clients frequently share with us how the knowledge gained from this book helped provide them tremendous clarity, shattering industry-pitched ideologies, while offering insight and direction in making such important financial decisions.
If you held concentrated amounts of your wealth in stock in any of those companies and had to sell at the wrong time, you would have lost huge amounts of your wealth. Those companies, including Martha Stewart, have since rebounded from their low points.
But the lesson remains true because the timing is often out of your control – entrusting a large percentage of your wealth to the performance of a single company places your portfolio at extremely high risk. And the risk accelerates the older you get.
Even though those companies rebounded, many others who have suffered similar losses did not, and they simply no longer exist. This was the legacy of the dotcom bust in 2000.
Hundreds of companies – including many here in the San Francisco Bay Area – offered stock options to their employees that were worthless by the time the companies folded. And the same trend occurred during the Great Recession.
The former chairman of Bear Stearns at one point owned a nearly $1 billion stake in the business. When the company collapsed in March 2008, he sold his shares for $61 million. That’s almost a 95% drop!
All that said, many people have also generated enormous wealth through concentrated stock options. So what’s the more common scenario for ultra-high net worth people who have a large portion of their portfolios invested in a single company?
Are they more likely to watch in horror as their financial foundations collapse in mere months, or ride off into the sunset with bags full of money? The answer is both simple and unnerving: No one knows.
You simply don’t know what will happen to your company, or another company in which a large percentage of your portfolio is invested and therefore dependent on.
How You Can Lose Big If You Hold on to Stock Options
There are a number ways your wealth can disintegrate in a flash if a large percentage of your worth is tied up in stock options in a single company. This is true whether you own it, work for it, or just own a lot stock in it, perhaps from an inheritance. Let’s look at a few of the most common ways:
Depending on the type of stock options you own, you might not realize that you have to exercise them before they expire. For employees, this date often comes ten years after you are granted the options.
But, if you get laid off, your window of opportunity to exercise your options shrinks dramatically, often down to just a few months.
If you aren’t paying attention and staying on top of your vesting schedule, grant dates and expiration dates, you can miss out on everything. About 10% of stock options expire each year, un-exercised. It’s a colossal waste of wealth potential.
If you don’t own the company, you are not in control of its fate. So if your company gets sold to Amazon or Facebook, or merges with another, you might lose all your unvested stock options.
Stock options are kind of like baseball cards in this way. They’re only worth money once you actually receive the money for selling them. Until that happens, they’re just nice to look at, but the money doesn’t actually belong to you.
The Value Declines
Other times, even when owners of stock options are paying attention, the company might just start to lose value. Maybe a competitor emerges. Maybe a new innovation renders one of your primary services or products obsolete. Remember the Blackberry? Still want to own that stock?
You can work your tail off for your company and still watch the value of your stock options fall, no matter what you try to do about it.
Waiting Until the Last Minute
People often have a hard time letting go. Because the stock market is akin to gambling, people have a hard time selling stock because of the fear of missing out. If I sell a year early, what if the value goes up a bunch after that? If I don’t play one more game of blackjack, how do I know I might not double my money?
See the parallel? You can’t make investment decisions with stakes this high based on what might happen. You need to make decisions based on what has happened, and on how you want to live the rest of your life.
Many people wait to sell their stock options until right before the expiration deadline. But how likely is it for that moment to be the peak of that stock’s value? Pretty unlikely. Waiting until the last minute does not maximize your value.
No one knows when any stock will peak. You cannot base your investment planning on that line of thinking.
Early Death or Key Life Changes
You or your spouse may die earlier than expected. You may encounter health problems in your family and have to change jobs or move. Dozens of other things can happen in your life that upend your best laid plans.
If those things happen, and large percentages of your wealth are still tied up in a company stock you held onto for too long, now you have to sell. And you might be selling for a loss or a much lower value than you could have gained had you sold a few years earlier.
A Different View of Stock Options
Here’s how Pillar Wealth Management looks at stock options:
The longer you hold onto them and the older you get, the more risky, less secure, and less desirable they become.
Picture yourself at age 67. Do you really still want to be holding onto thousands of shares in a single company? Why would you risk so much of your portfolio – and the potential benefits that money brings to your family and community – in the hopes that the value of the stock goes up just a little bit more?
The reward is not commensurate with the risk. A hallmark of smart investment planning is asset allocation. Wise allocation spreads out your assets across equities, bonds, cash, real estate, and perhaps other sectors. It mitigates risk and optimizes long term performance and security. 6 reasons why asset allocation is the #1 predictor of investment performance
Smart asset allocation presumes you want your money to fund your desired lifestyle, pass on to your heirs, and impact your community according to your priorities and goals. It presumes you want your wealth to achieve what matters most to you.
Restricting huge percentages of your wealth to a single company’s stock goes against all this. If that company loses value, or if any of the other scenarios listed earlier take place, you can suddenly be worth far less than you were just a few months prior.
Again – why put yourself at such a high risk? What’s the reason? As a high net worth or ultra-high net worth investor, you don’t need to be in the business of massive growth based on high risk investing.
You should be about wealth preservation, where you live the lifestyle your wealth already makes possible and can continue to make possible for the rest of your life if you build an investment plan around those goals.
Why High Net Worth People Struggle to Sell Their Stock Options
We’ve discussed some reasons, such as the fear of missing out on future gains that may never end up materializing. Other reasons include inertia – it’s easier to not make changes to things you’re familiar with. But one of the main reasons people don’t sell their stock options is taxes.
Regarding taxes, you should do everything possible to not sell your options within the first year after exercising them. That would cause them to be taxed as ordinary income, meaning you pay a high federal rate, as well as state and Social Security taxes.
If you wait beyond a year, they will be taxed as long term capital gains, which is a lower rate, and doesn’t include Social Security or state taxes in most states. Note: If you have non-qualified stock options (NSO), the tax consequences are less favorable than for incentive stock options (ISO), even after a year has passed.
Consult a financial advisor such as Pillar Wealth Management to develop a plan that works best for you. But still, even the long term capital gains rate takes a big bite out of the value of your stock options.
The thing is – so what? No matter when you sell, this is going to happen. Holding on to your stock options doesn’t make the taxes just go away. It just delays the inevitable. Meanwhile, your risk of losing a large share of your wealth increases each year you hold on to such a concentrated position.
How to Overcome the Stock Option Tax Bite
You have a few options for how to minimize the tax burden when you sell your stock options. First, you can simply pay the long term capital gains tax and then reinvest your proceeds in a diversified asset allocation that gets rebalanced regularly.
Using an investment process that is both holistic and driven by historical market performance data, at current tax rates you only need to earn an additional 1.75% growth for ten years to offset your taxes.
That is actually a very achievable goal, especially when you use an investment process like this one. The sooner you sell your options, the more time you have to grow the proceeds using smart investment planning and asset allocation.
Second, you can work with an experienced wealth manager who understands estate planning and the many types of trusts you can make use of to avoid some of the taxes while ensuring your wealth’s long term stability.The details of trusts and estate planning are complex, and we don’t have room here to explore them in any depth.
But if you are determined to protect your wealth for the rest of your life and beyond, and are serious about long term wealth preservation instead of the risk of highly concentrated stock options, it is time to explore your choices for what you can do after you sell your stock options.
After selling your options, you will feel less anxiety and stress about your wealth.
Why? Because now you have the money. You’ve gotten rid of the baseball card and turned it into actual cash, before the card got ruined in a flood or a fire, or got stolen, or lost its value because of some dirt someone dug up about the player that turns everyone against them.
Having the money is more secure than having the stock options. Once you have it, you can work to preserve it, grow it, enhance, it, and use it. Before you have it, you really don’t have anything. Except the potential for losing it.