Sears

Toys ‘R Us

Lehman Brothers

Nortel

American Savings and Loan

Enron

GM  

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This is just a tiny list of the massive companies that went broke, taking their shareholders with them.  What else do they have in common?  I would bet my life that a huge portion of the employees that worked at these companies were way to invested in their own company’s shares.

I personally know a man who put more than $700,000 into Nortel while he was working at the company.  He lost his job, and also refused to sell the stock at a loss and ended up with nothing.  He’s still working today, in his 70s.  It was all so avoidable.

Most large companies want their employees to have skin in the game.  They will come up with many ways to compensate their employees with company stock, or create share purchase programs that offer a discount.  This is done for a good reason, but these types of compensation programs also create over-concentration issues for their employees.  No one should have more than a few percentage points of their net worth invested with one company.  Ever.  When you work at that company, you are magnifying the risk even more, because you can get laid off at the exact time that your stock is crumbling.  Just ask any former Nortel Employee.  Before you scoff and say "my company isn't Nortel," remember that Nortel was MASSIVE.  No one thought it was going to fail, until it did.

The prudent thing to do would be selling your company shares as soon as possible and diversifying into hundreds if not thousands of securities.  This seems obvious, but most employees don’t do it.  I think it’s because of a fundamental misunderstanding with the stock market.  People don’t realize that the stock market is forward looking.  They look at the current stock price and say “wow, if the price is x today, and we have all these new features to release, or a new product coming to market, or we’re opening 20 stores a year, the stock is going to get way higher.”  What they don’t realize, however, is that the projected growth from new releases, features or products are already priced in to the current stock price.  Analysts and Portfolio Managers are well aware of the growth potential of your company.  They are basing their expectations on future revenues and profits, not today’s.  That’s why companies that have never turned a profit are valued at billions of dollars right now…

The expected return on one stock in the S&P 500 or the TSX is roughly the same as the index itself.  If the expected return was ever higher, the price of the stock would rise and then would again be in line with the overall index.  When you are invested in one stock, you are not magnifying your expected returns, you are just increasing the range of possible outcomes.  You are taking on more risk for no reason.

If you are absolutely determined to ignore my advice and hold enormous amounts of your company’s shares, at least move them to a TFSA, where the profit is non-taxable. If you are holding your shares in a non-registered account, all your profits are going to be taxed.  For instance, if you own Microsoft shares, you need to pay tax on foreign dividends and capital gains.  You pay tax on dividends in the year you receive them, but capital gains tax is only owed when you trigger the capital gain.  This deferral of tax is a huge reason why employees/shareholders don’t move their stock to a TFSA or RRSP immediately.  They don’t even realize that they are building up a taxable event.  By then it’s too late.  

In summary, you should be diversified, but if you insist on holding a large amount of one company’s stock, at least don’t pay tax on your profits.

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