Chances are if you work in the technology industry, part of your compensation will include company stock. We’ve written about various forms of equity compensation before (RSU’s here and here, ESPPs here and here, Stock Options here) but today we want to address a question that anyone investing in their company ultimately has to answer: How much company stock should I own?

While there’s no one-size-fits-all answer to this question, there are three factors you should consider.

Let’s jump in!

What Are My Chances of Beating the Market?

Before answering the specific question of how much company stock you should hold, it’s important to understand the odds. In other words, should you expect to have an advantage investing in your company’s stock?

Unfortunately, setting aside any vesting requirements or favorable tax treatment, the answer is no.

Hendrik Bessembinder in his 2017 paper ‘Do Stocks Outperform Treasury Bills?’ finds that “Four out of every seven common stocks that have appeared in the CRSP database since 1926 have lifetime buy-and-hold returns less than one-month Treasuries.”

The base rates for investing in any individual security is a lower expected return with more risk! Not a bet you should be tempted to make.

Why is this? The risk part is intuitive. The more we diversify, the more we spread our bets and aren’t tied to the prospects of one individual company.

The return part is less intuitive. Why would we expect a lower return for any randomly selected stock?

To understand this, we have to consider the concept of positive skewness. With any stock your maximum loss is capped at 100% while your upside is technically unlimited. Because of this, the odds are that any randomly selected stock should be expected to have a return less than the market. The stocks that perform really well pull up the average while most stocks (nearly two-thirds according to research by Longboard Asset Management) underperform the index.

They find over the period from 1983-2006:

• Nearly 2 in 5 stocks actually lost money (39%)
• Nearly 1 in 5 lost at least 75% of their value (18.5%)
• Nearly two-thirds of stocks (64%) underperformed a broad index of US Stocks (The Russell 3000 Index which represents around 98% of the investable U.S. equity market)
• Only 25% of the stocks were responsible for all market gains

What About Risk Tolerance?

Once we’ve calibrated expectations, we need to consider risk tolerance. Here, there are two factors to consider:

1. Our willingness to take risk
2. Our ability to take risk

Think of willingness as the ‘sleep-at-night’ factor. How comfortable are you in your gut with the up and down roller coaster ride of holding a meaningful amount of money in your company’s stock?

Ability is more quantifiable. The ability to take risk depends on your cash flow needs, age (or proximately to retirement), time horizon, and the positioning of your assets. These questions can all be answered with the help of a financial plan (see this and this).

A Rule of Thumb or Starting Point

If you do any “googling” on this topic you will quickly find that most professionals recommend a maximum of 10-15% as a rule of thumb for how much your company stock should makeup your total investments.

This is a helpful starting place but the right answer for you will vary based on the factors above.

That said, another way to look at is not in terms of percentage but in terms of the downside.

How much stock could you hold so that if it declined significantly you wouldn’t need to change your financial plans. And are you comfortable risking this amount?

If yes, maybe this level of risk, while not optimized financially, is the right decision for you given a desire to benefit from the upside of your company’s success. However, on the other hand if you’re thinking about retirement and desire to maximize the odds of doing that as planned without extending your time horizon, taking some risk off the table is the smart bet.

In an upcoming blog we will dive deeper into this topic by addressing the best types of equity compensation to hold (if you chose to do so) and a process to maintain your desired target over time.

We Can Help

Lastly, if you’d like some help managing your company stock and planning for the key financial variables that will impact your success, get in touch. We’d be happy to talk about your individual situation in detail.