In the late ’90s, I had a client who was excited to see his stock options increasing at a rapid rate. Over the course of a few months, he saw the value of his options increase four times, and he was a millionaire on paper literally overnight.
Wanting more and thinking it could never go down, he chose to hang on and subsequently watched his newfound wealth vanish. After a few years, the options expired as worthless, and he is now left remembering how good it was for that short time.
While investing in your company’s stock options may sound like a great perk, weigh your choices carefully before taking this step.
The pros of investing in your company’s stock options
There are several pros to investing in stock options, particularly when you are working for an established company that has growth potential.
- As a company employee, very often you will be offered discount rates to invest.
- The company you work for may match or partially match your investment.
- You have a vested interest in the company, which means you are more vested in the company’s success.
- Company morale and turnover tend to be lower where employees are able to purchase company stock options, and this can lead to a more pleasant work environment.
- You may get a higher return or a guaranteed return on your investment.
The cons of investing in your company’s stock options
The above points may make it seem like investing in your company’s stock options is a no-brainer, but there are some risks involved. Here are a few:
- Lack of diversification. When you make an investment, you typically want a diversified portfolio. When you invest only in your company’s stock options, your entire portfolio is in one place—and that can be risky.
- Your financial security is dependent on the success or failure of the company at which you are working.
- If the company goes under, you will be hit twofold. You will not only lose your job but you will also lose your investment.
- There are usually limitations to selling your stock options once they have been purchased.
Deciding whether or not company stock options are right for you
After hearing the cons, you may be questioning whether or not owning your company’s stock options is actually a good idea. It can be a difficult decision, as there are some compelling reasons to buy and some compelling ones to stay away.
Here are some tips if you are thinking about purchasing your company’s stock options.
Never invest your money just in your company’s stock options. Most experts will tell you that no more than 10 percent to 15 percent of your investments should go into purchasing your company’s stock. I couldn’t agree more.
- Research your company carefully before purchasing. Don’t just take your boss’s word for this being a good investment. Instead, do what you can to find out the company’s financial state and whether or not it is stable.
- Think about whether or not you believe in the company. How do you feel it is run? Is it really a place where you feel comfortable investing your money?
- Carefully read investment terms and know how the company’s plan works. When you buy, does your company guarantee a certain percentage return? Does the company match your purchases? What are the terms you must follow if you decide to sell your stock options down the road?
- Find the balance. If you decide to invest in your company’s stock options, make sure you are balancing out your investments by also investing your money in other places.
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Jeff Rose is an Illinois Certified Financial Planner. He blogs at Good Financial Cents and Soldier of Finance. He loves Crossfit workouts, writes about Roth IRA rules and craves In-N-Out burger. You can follow his updates on Twitter.