When to Sell ESPP Stocks

Wondering when to sell your ESPP shares acquired through your company's employee stock purchase plan? It all comes down to asset allocation, financial planning and risk management. Let’s help with this investor’s question:

Q:

I'm 59 and plan to retire in a few years from a pharmaceutical company. I have a block of stock options that will soon expire. I was considering exercising them and holding the stock for a year or two, hoping for the stock price to go up and potentially benefit from long-term capital gains. I'm concerned that if I sell now (at a modest gain), the price will go up right after I sell. However, this will leave me with about 10% of my portfolio in company stock – about double what it is now. I'm also participating in our company's ESPP, adding more shares to my holdings. When should I sell the ESPP stock – or should I obtain and hold it for now?

A:

Taking advantage of an employee stock purchase plan can be a great way to help build wealth. ESPP participants often benefit from purchasing company shares at a discounted price, sometimes up to a 15% discount off the fair market value on the offering date. Receiving stock options, discounted shares or dividends on those shares can be looked at as virtually "free money." However, understanding the offering period, purchase date and holding period requirements is crucial for making informed decisions and effective financial planning.

But it's never a good idea to rely heavily on one individual stock – even when it's the stock of your employer. Over-concentration in company stock can expose you to unnecessary risk. Unfortunately, there have been a few high-profile cases where workers had most or all of their 401(k) accounts invested in company stock – and they lost all their money (and their jobs) when the companies went broke. Those are extreme examples, of course, but the principle remains that you should not have all of your eggs in one basket. Diversifying your portfolio is a key aspect of effective financial planning and investment management.

We don't know what company you work for or what the prospects are for its stock performance or market value. But this isn't a conversation about the individual stock; it's really about asset allocation, equity compensation and risk management – that is, having a balanced and diversified portfolio that fits your level of risk and reward. Understanding how stock options, ESPP shares and other forms of equity compensation fit into your overall financial plan is essential. The ESPP plan documents provided by your employer can offer insight into specifics like the enrollment period, purchase period and plan specifics.

As you point out, in your case, if you were to exercise the stock options, your company shares would make up 10% of your portfolio. While circumstances differ, our guideline for most clients would normally be to invest no more than 3% of their assets into any one security. You're already at 5%, and increasing to 10% may expose you to a higher risk than you're comfortable with, potentially affecting your long-term gains and overall financial health.

If you do exercise the options, you're then faced with the decision of whether to hold the shares for a while to meet the holding period requirements for a qualifying disposition or to sell them immediately. And of course, there’s still the question of when to sell your ESPP stocks. Like all investors, you'll fear two things: watching the stock price rise after you sell or watching the price fall after you buy. So whatever you decide, don't watch the share price every day – that may tempt you into making an emotional or fear-based decision, rather than making informed decisions based on solid financial planning.

While we don't have a crystal ball to predict when to sell an ESPP you've been offered, you now have some guiding principles for how much to invest in one company's stock while keeping a balanced portfolio. Remember to include your tax professional in the conversation as the IRS has specific tax implications for ESPP shares, including potential compensation income reported on Form W-2 and the need to report sales on Schedule D. It’s important to understand the differences between a qualified ESPP and a nonqualified ESPP, as well as the tax consequences of a disqualifying disposition. The best advice we can give you, of course, is to consult with an independent financial advisor – one who will always put your best interests first when it comes to investments and help you navigate the complexities of personal finance, tax planning and wealth management.