Planning Around Stock Compensation: Taxes, Timing, and Down Markets

What is Direct Indexing and How Does it Work? with Pat McStay

Top Executive Compensation Strategies You Should Know with Laura Balser

Disclosure: 0:00

The following presentation by Monument Capital Management LLC is intended for general information purposes only. No portion of the presentation serves as the receipt of or as a substitute for, personalized investment advice from Monument or any other investment professional of your choosing. Please see additional information disclosure at the end of this presentation. A copy of Monument’s current written disclosure brochure discussing our advisory services and fees is available upon request or at wwwmonumentwealthmanagement.com.

Emily Harper: 0:25

By mapping this all out for people. I’ve seen this actually spark decisive action. You can really start to build a strategy based on facts and numbers versus feelings and assumptions.

Jessica Gibbs: 0:44

Welcome back to Off the Wall. I’m Jessica Gibbs and I’m here with my fellow Monument business partner and financial planner, Emily Harper. Hi Emily, Hi Jessica. So we have Emily here today because she is our resident stock option specialist here at Monument. So obviously we’re talking about stock comp today. I think you could expand this conversation, even if you had a concentrated position in your portfolio due to growth, If it’s something like Apple or Microsoft that has experienced a lot of exponential growth over time and you have a large weight in your portfolio to that.

Jessica Gibbs: 1:14

So keep that in mind as you’re listening to this. I mean imagine having a significant portion of your wealth tied to one particular stock and never thinking about it. Believe it or not, it’s actually common, particularly for people who have stock-based compensation. So equity compensation it can be a powerful tool in helping you build wealth.

Jessica Gibbs: 1:36

We tend to see three common mistakes when it comes to people who are building wealth through stock-based compensation. So, number one not understanding tax ramifications. Number two, going it alone, and by that I mean not having the right team in place to give you advice and support. And number three, a mindset that causes people to take on too much risk. So we’re actually gonna narrow in on that third mistake today, Because the thing about concentrated stock is you’re probably feeling really good when the stock is going up, but I want you to do a gut check. How would you feel if that stock was going down 10%, 20% or more and that was money that you were counting on for a house down payment, paying for college, maybe retiring in a few years? So I want to unpack that mindset that you may be taking on too much risk and, Emily, I want to start with that. So what are some of the common risk mentalities that executives who own company stock have?

Emily Harper: 2:40

I think a big one to start with is just overconfidence and identity bias. So a lot of executives equate the company’s success with their own and the hard work that they’re putting into delivering value, and that can definitely create some blind spots in assessing risk. So people who give so much of their time and energy to building value in these great companies, they have a lot of confidence in their share price rising and over time it’s likely that it will rise. But no company is immune to shocks in the market and I think we’re seeing a lot of that systemic risk right now in what we’re seeing with market volatility. So that’s a big one and that’s a really personal one and it’s hard to be mindful of, but it’s an important one, I think.

Emily Harper: 3:29

Another is just fear of missing out. That’s a very human emotion. Nobody wants to think that they too long in the hopes of getting even more upside, even when the stock is already overweight in their portfolio. So think about what would make you lose more sleep at night Missing out on a 10% gain in your company’s stock because you sold some while still locking in a healthy gain, or losing 20% or more in value because you just held on too long.

Emily Harper: 4:10

I think, another thing when it comes to this fear of missing out, it’s important to keep in mind just because you’re selling your company stock, that doesn’t mean that you won’t have opportunities to grow the proceeds or to continue to enjoy things like dividend income if you’re working for one of those great blue chip companies that pay a high dividend. So if you’re selling to diversify, you may be investing in a more broadly diversified portfolio that can grow your wealth with potentially less risk. So if you can acknowledge that FOMO and move beyond it, it can be a powerful way to still allow your wealth to grow with a little bit less risk. I think another big thing is the tax issue.

Disclosure: 4:55

You mentioned.

Emily Harper: 4:56

We won’t really be diving into that today, but I think there is a resistance to selling stock because people just don’t want to pay the taxes on the gains. We call this letting the tax tail wag the dog. We love our dogs here at Monument, but we don’t like letting taxes be the driving factor, and a narrow focus on taxes can come at the expense of really maximizing opportunity and optionality when it comes to your stock-based compensation. You hit on this a little bit, jessica, but I think a fourth big one is mental accounting, which is just the propensity for people to allocate money to very specific purposes. I think we hear this a lot in our discovery meetings. People will say things like oh, when this stock vests, I’ll have money for my kid’s tuition, or this tranche will cover my down payment on the beach house we’re planning to buy.

Emily Harper: 5:51

So mental accounting can lead many executives to not do the proper planning for funding near-term goals that are important to them, which is especially risky when the value of your stock-based compensation isn’t guaranteed and can be influenced by forces outside of your company. But when you have these mindsets, you know I don’t want to miss out on gains, I don’t want to pay taxes. You miss seeing the big risks you may also be taking, particularly concentration risk. So a lot of these things lend themselves to concentration risk, which is essentially the risk of amplified losses that may occur from having a large, a large portion of your portfolio in a particular investment. And, jessica, I love you know you’ve given people like really simple advice on how to assess their concentration risk, so could you share the little mental exercise that I’ve heard you talk about?

Jessica Gibbs: 6:46

Yeah, this is just a rule of thumb, but it’s a great place to start.

Jessica Gibbs: 6:49

If you’re not sure what to do, just do the math, and by that I mean add up your entire portfolio, so that’s your taxable investments, your retirement accounts, company stock, don’t include your house. And what percentage of that total portfolio is your stock? At Monument? We generally like to see a client’s company stock be no more than 10 to 20 percent of their portfolio, depending on their risk tolerance, their risk capacity as well. So just start by doing the math for yourself, and if you find that your company stock is more than 10 or 20% of your overall portfolio, that’s usually a sign that you should be thinking about okay, how am I going to exit this stock In light of all those things that you talked about? Right, with the taxes and the fear of missing out on future gains, kind of all those mindsets of keeping those in mind, it’s still a good temperature check for you to be like okay, this is like a quantitative way for me to tell I need to start thinking about selling stock.

Emily Harper: 7:54

Okay, elegance and simplicity, right, right.

Jessica Gibbs: 7:57

Yeah, I think you can think about it another way too. If you’re concerned about this about concentration risk is that your compensation is tied to this company as well, so you’re always going to be concentrated in this company, whether that’s through compensation or whether it’s through stock that you own in the company. So it’s important to be thinking about actively thinking about diversifying your financial life and seeing your stock-based compensation be just a piece of that, not the entire driver executives that we work with.

Emily Harper: 8:26

They’re usually really focused on accumulating stock compensation and growing their wealth. We actually did a great episode of off the wall on executive compensation strategies with laura balser Ferry, so we’ll link to that in the show notes. But I wanted to talk about the phrase sell strategy, because just as important as accumulating is knowing when to sell and what to do with all of this that you’ve accumulated. So when we talk about sell strategy, what does that mean and how can we think about this in the context of market volatility like we’re seeing right now?

Jessica Gibbs: 9:03

So that phrase self-strategy to me very simply means being systematic about taking your wins or leveraging your losses and reducing your concentration risk timing from the equation, because your sell strategy should be consistent, it should be intentional and it should be regardless of market mood.

Emily Harper: 9:29

Now, having a systematic strategy or rules around when to sell shares of your company stock can be challenging to navigate, especially if you have multiple sources of stock-based compensation. If you have multiple sources of stock-based compensation, like options and RSUs, or if you participate in employee stock purchase plans and accumulate shares on a regular basis. So what are some things you should be aware of if you’re trying to build a sell strategy?

Jessica Gibbs: 9:54

So a good wealth manager, I think, is going to help you try to avoid violating wash sale rules. So what is a wash sale? Let’s decode that jargon. A wash sale is basically when you sell a security for a loss for the tax benefits and then you go around and you buy the same or similar security. If you do that within 30 days of before or after the sale, you won’t be able to take that loss on the security on your tax return.

Jessica Gibbs: 10:21

So wash sales are particularly important if you are purchasing company stock on a regular basis as part of, say, an employee stock purchase plan. If you own publicly traded stock, I think you can leverage such tools as direct indexing, which is a fancy way of letting you quote, unquote, work out of or sell over time, in more plain language, concentrated stock. So, and if you own private company stock, direct indexing can still be helpful with still be a helpful tool for diversifying your risk in your portfolio, maybe around your industry, for example. So what is direct indexing? You know I’m like just throwing out like all sorts of jargon in this answer but I swear it’s not as complicated as it sounds.

Jessica Gibbs: 11:12

So stick with me on this. It’s going to be a kind of a long explanation, but and it gets a little in the weeds, but I think it’s interesting. So direct indexing involves usually individual stocks to replicate the performance of an index. So, for example, the S&P 500. You can go out, you can buy a mutual fund or an exchange-traded fund often called an ETF that owns a lot of different companies, often called an ETF that owns a lot of different companies. So think of it like a basket of all the holdings in it, and you own the basket, not the individual holdings. That’s one way to go out and buy an index. Alternatively, you can buy individual shares of what’s best for you, not the whole bundle, and still be able to replicate the performance of that overall index. So back to our S&P 500 example. You don’t need to go out and purchase all 503 stocks in the S&P 500. You may be able to get a similar return by just owning significantly fewer stocks.

Jessica Gibbs: 12:15

And when you own individual stocks, there are more opportunities to take advantage of incremental tax losses that happen throughout the year, and this is what’s called tax loss harvesting. So when you own an ETF or a mutual fund, you can’t do tax loss harvesting as frequently, because you would need the whole fund to decrease in value from when you bought it. And when you have more tax losses, you have more leverage to offset those losses against gains elsewhere in your portfolio or, in this instance, with concentrated company stock. So direct indexing is also really cool because it can adjust to your unique tax situation and your specific investment preferences. So, for example, if you had environmental social governance preferences those are often called ESG preferences or you wanna avoid investing more in your company or in your industry, direct indexing is a great way to do those things.

Jessica Gibbs: 13:15

It also helps you avoid wash sales, which is one of the things we talked about earlier. So Monument relies on really advanced software to do this for our clients. So all this is to say is that direct indexing is a really powerful tool, but it’s really difficult to do on your own, and that’s where a good wealth advisor can add a lot of value. In this space and I know you mentioned the episode we have on stock compensation I do want to point out also we have an episode that delves a lot further into direct indexing with Pat McStay from O’Shaughnessy Asset Management, so we can link to that as well for people who have these really complex financial lives.

Emily Harper: 14:03

You know, something else that can go a long way in building a sell strategy is tax planning, beyond just the tax loss harvesting that you mentioned, jessica. So an exercise that I like to do with people is mapping out their future vesting for RSUs and options to get a sense for what their tax bill is actually going to look like year to year. There will be things outside of your control, like restricted stock that vests and that’s just taxable income that you’re going to have to realize. But then there’s also things that are in your control, like exercising your options, either incentive stock options or non-qualified stock options. So by mapping this all out for people I’ve seen this actually spark decisive action you can really start to build a strategy based on facts and numbers versus feelings and assumptions about what the tax impact would be of selling to diversify.

Emily Harper: 14:54

So, the tax planning does go a really long way. Don’t have time to dive into all of that today, but I think it’s always helpful to have some kind of visual that helps you really pull this all together and really see to your point how stock options fit into the entirety of your wealth plan, not just a piece of it.

Jessica Gibbs: 15:15

Yeah, I think it’s comforting to know like, yes, you’re going to have the tax bill this year, but you can visually see like you have all these other tranches that will be vesting in this upcoming year and so you know more stock compensation is coming and you know your bonus at the end of the year is going to have a stock compensation component to it and, like you, just you can see visually how this is going to keep progressing. You’re going to keep participating in the company stock.

Emily Harper: 15:38

It’s rinse and repeat.

Jessica Gibbs: 15:39

Yep, let’s talk more specifically about how to think about stock compensation during periods of market volatility. Even with the most disciplined sell strategy executives still feel helpless when the markets are rocky and they feel like they need to take action. So we talk a lot about not being reactive to the markets, but are there some good actions that people can take if the markets are going down rather than up?

Emily Harper: 16:10

Yeah, this is a great question and it’s so timely right now. First, I think it’s helpful to put stock market volatility in the context of what it may actually mean for stock based compensation and overall wealth planning. So volatility and a down market that impacts your share price, that doesn’t inherently have to be a bad thing, especially if you are someone who is accumulating and you’re planning to hold on to shares of company stock for the long term, say you’re not at that point of over concentration yet and you’re really still building. You know there are some benefits to a down market, or that comes in the form of shares. The down market might work in your favor because you’ll be receiving a higher number of shares to meet that dollar amount and those shares will ideally grow over time if you’re really in it for the long term.

Emily Harper: 17:11

Even if you have a set number of shares set to vest and the share price takes a hit, if we put our tax hat on you may have less taxable income than you otherwise would have had when the RSU is vested or when you exercise options. So, again, if you plan to hold on to your shares, this can actually be seen as a good thing. A little bit opportunistic Now where you might want to take action potentially, this is very specific to incentive stock options. But you know A decrease in your share price means less out-of-pocket cost for you to exercise your options. So with incentive stock options you really can’t do cashless exercise like you can for non-qualified stock options, because you have to hold the shares to really get that beneficial tax treatment. So less out-of-pocket cost for you, less cash coming out of your pocket to buy those shares, can be a good thing. So it’s worth taking a look at the options that you have and whether it makes sense to go ahead and exercise some.

Emily Harper: 18:14

In a down market, the biggest negatives and drawbacks when it comes to market volatility or a decrease in your company’s share price it’s really for those people who are relying on the value of their stock for their short-term needs. You know this really isn’t any different than any other person relying on their investment portfolio for similar needs. So this is where we talk a lot about cash is king and really like planning for your cash needs and understanding what those are. So you know if your stock price is down and your shares are about to vest, if you’re relying on that money for short-term needs or just lifestyle maintenance and it wasn’t what you were planning on receiving you have to ask yourself where else am I going to go to get this money that I need? Is it going to come from savings or other parts of your more diversified portfolio?

Emily Harper: 19:05

So if you’re not forward thinking about what those cash needs are and planning for them, and you have to go to your portfolio in a down market, this really has the potential to derail your overall financial wellness. If you’re really considering your equity-based compensation as available to fund your current needs, you might need to sell something else at an inopportune time and really lock in those losses. So this is where that planning is so important not just mapping out from a tax standpoint, but also mapping out what your cash needs are and how you’re going to fund those. This is why holistic planning that considers your equity-based compensation as just a piece of a larger wealth plan is so important. You’ll have a plan in place for those cash needs and you won’t have to make those knee-jerk reactions or have that stomach-turning feeling when you see your company share price just going down day after day after day and your vesting period is about to come up.

Jessica Gibbs: 20:04

Yeah. So I’d add two things to that. That was great, I mean. The first is I think as an employee, you know your company stock in some ways far better than any analyst does. I mean you know the leadership, you know the strategic direction of the company, you know the product pipeline. So the timing on when to sell your company stock I think is influenced by your sentiment on the company and if you’re feeling positive about the direction of the company over the long term, don’t panic. Basically. And second, I think your point about emotional gut check is such an important one that I want to underline, because when you are seeing your company stock go down, it’s you know, people have a different sentiment on risk when the market is going up than they do when the market is going down.

Jessica Gibbs: 20:51

So it’s like when you see your company stock decreasing in value, you know, think of that as the emotional gut check to be like how comfortable am I with stomaching seeing my value go down and do I need it To your point? Do I need this money for other reasons? So if you are reinvesting proceeds of your stock that you’ve sold, you aren’t necessarily locking in a loss. If you’re deciding to sell that company stock in a down market, you’re just recalibrating and reducing risk, all hopefully with an opportunity to recover over the long term in a diversified portfolio.

Emily Harper: 21:27

Yep, there is a world of growth outside of your company. Potentially, you know back to the emotional part of this too. It could also really be the gut check that you need to sit down and map out all of your equity compensation. Both you know what you currently own and the shares that you expect to vest or options you expect to exercise in the future. And this is just one component of cash flow-based planning that we do with clients. We look at the actual cash compensation they have coming in, how it’s being allocated across spending and saving and how stock-based compensation contributes to the cash flow picture. So you know exactly what’s needed to meet your goals. Without the mental accounting, without the risk or at least reducing the risk of market volatility impacting your wealth, plan To put a finer point on it.

Jessica Gibbs: 22:14

Stock compensation really is this ongoing cycle of planning cash flows for future stock vests, grants, that schedule that you talked about, planning for taxes around when you’re going to receive the grants, you’re exercising options, you’re selling vested shares whatever it may be and planning for diversifying your portfolio. If you’re going to build wealth with purpose, you need to integrate all three of these things. So thank you, Emily, for having this great conversation with me, thank you, Jessica, and thanks to all of you for listening.

Life moves fast, keeps evolving, so does the market. So knowing your options helps you act and makes decisions with intention, no matter what life throws your way. Subscribe to our newsletter to get more thoughtful, strategic wealth advice from our team at Monument Wealth Management. You can go to wwwmonumentwealthmanagement dot com backslash subscribe. So see you in the next OFF THE WALL.

Disclosure: 23:19

The previous presentation by Monument Capital Management LLC was intended for general information purposes only.

Disclosure: 23:25

No portion of the presentation serves as the receipt of or as a substitute for, personalized investment advice from Monument or any other investment professional of your choosing. Different types of investments involve varying degrees of risk. It should not be assumed that the future performance of any specific investment or investment strategy or any non-investment related planning services, discussion or content will be profitable, be suitable for your portfolio or individual situation or prove successful. Neither Monument’s investment advisor registration status nor any amount of prior experience or success should be construed that a certain level of results or satisfaction will be achieved if Monument is engaged or continues to be engaged to provide investment advice services. Monument is neither a law firm nor an accounting firm. No portion of its services should be construed as legal or accounting advice. No portion of the video content will be construed by a client or prospective client as a guarantee that he or she will experience a certain level of results if Monument is engaged or continues to be engaged to provide investment advisory services. A copy of Monument’s current written disclosure brochure discussing our advisory services and.

0:00 Important Disclosure

1:00 Introduction to Stock-Based Compensation

1:40 Common Mistakes for Building Wealth Through Stock Compensation

2:40 Common Risk Mentalities of Executives

5:26 Assessing Concentration Risk

9:00 Building a Sell Strategy

15:40 Market Volatility and Stock Comp

22:00 Episode Wrap-Up and Resources

23:20 Important Disclosure

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OFF THE WALL is a podcast for business professionals and high-net-worth investors who want to build wealth with purpose. A little bit Wall Street, a little bit off-the-wall; it’s your go-to for straightforward, unfiltered wealth advice on topics that founders, business owners, and executives care about.