Cfrgtkky

I'm just finishing up paying off my student loans (woohoo!) and am starting to look at places I can put my money to make it work for me. I've read Kobliner's Get a Financial Life and am interested in starting with ETF's, but I have a slight dilemma.

I work for a medium-sized company that is publicly traded on the NYSE¹. They offer a program where I can allocate up to 15% of my paycheck (after tax) to buy their stock at 85% of the price. The only stipulation being that I have to hold it for 180 days (~6 months).

To me this seems like free money. The second that stock is bought, I've already made 100/85 => 17.6% on my money!

I'm very tempted to allocate the full 15% of my paychecks to this, but I know that it's important to diversify my investments.

I was planning to use 20% of each paycheck to play with for investments--would 15% company stock/5% ETF be diversified enough? Should I drop to 10%/10% or lower? Is there some reason I'm missing to not go all in on this?

EDIT:

I don't think this is a duplicate. The marked duplicate is asking (very broadly) how often "is good" to invest in an ESPP. I know I'm already going to be investing every chance that I get. My concern is one of diversification, which the duplicate makes no mention of. I've made it clear that I'm comparing between ESPP and ETF, while the duplicate seems to simply ask "what are you experiences with ESPP?"

^{1. It's worth noting that this company's stock has done incredibly well in the last 10 years. While I'm not expecting it to keep the same growth it has, this company is definitely not going anywhere anytime soon. An investment with them would definitely be safe. I have the utmost confidence in this company.}

It's not necessarily free money. If the stock declines by >15% in the six months after you buy it then you've lost money on the deal.

However assuming your company is performing at least reasonably compared to other stocks, you are, on average, getting a 15% bonus to your savings. You shouldn't be turning your nose up at that. (if whatever other stocks you invested in declined 15% after you invested you'd lose 15% instead of just breaking even).

There is a bit of a diversification factor in that not only would you be keeping your savings in one company, but its a company you work for. If it goes under, not only are you short some savings but you are also out of a job.

However the diversification problem is short term. You only have to keep the shares for 6 months, and you can sell them after that.

Let's say you are earning $50,000 and can afford to put $10,000 (20%) into savings. The first six months you put $7500 into your company, $2500 elsewhere. You are pretty vulnerable for that six months, but it's only six months.

In the second six months you again put $7500 into your company, but you also sell the original $7500. Now you have $7500 in your company but $12500 elsewhere. That makes you much less vulnerable. After a few years you are pretty diversified, and you've taken full advantage of the 15% bonus.

EDIT: I'm not recommending selling as soon as you can as necessarily the best strategy. Lots of factors would affect that. I'm setting out this scenario to illustrate how to maximize your diversification.

This is probably above your pay grade but if your company's stock offers options, there are a number of hedging strategies that would protect you.

The simplest one would be to buy 6 month puts whose break even was less than 15% out-of-the-money. You'd be throwing away that premium but it would protect you against all loss of principal.

As a random example, consider a similar 15% opportunity today with IBM at $136.00. 15% lower is $115.60 and below that you'd lose money. Buying the Oct 120 put (7 months) for $3.75 gives you a break even price of $116.25, below which you are 100% protected. The worst case scenario is that you make 65 cents and the best case scenario is that the investment appreciates above $136.00, providing an additional profit beyond the above numbers ($20.40 - $3.75 + share price appreciation).

If IBM were to drop to near or below $120 before October, the put would also gain time value and the net position would be worth more than the break even values. I'll leave it at that since this is another rung up the option food chain.

If I had this 15% discount opportunity with savings on the side and I wanted to hedge, my preference would be a modest debit OTM long stock collar - potential to make 10% more to the upside (above and beyond the 15%) and the potential to lose only 10% of the 15% to the downside (yes, another rung up).

If your stock does not offer options and I've you believe that it's a fundamentally sound company, I'd still load up on it, to the maximum of 15% if you can manage it. The 15% is absolutely free money. You may lose it due to market conditions but that 15% is not your money being lost.

Investors in the market lost 20-25% last December. I think that every one of them would be thrilled to have been shielded from the first 15% of loss. You're young and losing 15% of your salary in 6 months is painful but not the end of the world (your company goes belly up).

When I first started investing 40+ years ago, I opened a number of DRIPs with companies that offered a 5% discount on dividends as well as a 5% discount on new money. It definitely helped with the early stage of my accumulation phase.

And FWIW, I employ some synthetic option strategies that offer a downside buffer of 15-20% with an upside cap of maybe 10%. Most of the time, this is captures a large part of the up moves and avoids most of the downdrafts.

Should you decide to follow this advice and you lose it all, I'll be changing my handle ;->)

One perspective is to consider the ESPP purchase as having the same restrictions, but purchased on the open market (and not associated with your employer):

1. The stock in this case would be a comparably-performing company in the same sector as the one you're working at (such as a competitor).


2. You have to escrow funds over the next six months to buy it


3. When you buy it, you get a 15% discount off a start/end-of-period price lock


4. You have to hold it for 6 months after purchase

If it's a good purchase under those conditions, it probably makes sense for you as an investment. Item 3's condition may be sufficient reason to buy the stock of any stable company on the open market under these terms.

Think about Allocation

Ignore the discount for a moment. Ask yourself, "How much would I invest in my employer in a vacuum?"

50% of your portfolio? 5%?

There's some value that you are going to feel good about, based on your risk tolerance, and your evaluation of your employer. Give yourself a small bump for the 15% price discount, and target that number.

Example

Say, without the discount you would be comfortable putting 10% of your investments in your employer and 90% diversified.

Bump the 10% up to 12% to account for the price discount, and go. After a year or two, reevaluate. If you still feel good about the company, consider selling the vested stock and moving it to your ETF.

Now your ETF is almost 100% of your assests - you can up the allocation for your company stock above 12% to rebalance toward the distribution you wanted. Repeat every year or two.