The Difference between RSU's and Stock Options
RSUs and stock programs are different, and should be treated differently.
If you work in today’s big technology industry, it is very likely that you are getting some form of stock based incentive, as part of your compensation. The two most common forms of compensation are restricted stock units (RSUs) and stock options. These two programs both offer very nice incentives for employees, but they are slightly different, and should potentially be treated differently. Also, any time that you hold some form of company stock, you should view your exposure to the company from a holistic perspective, to your overall portfolio.
What is an RSU?
RSUs, are awarded to employees at some date, and typically have a vesting period at some point in the future. Often the vesting will be 25% at the current date, and 25% in one year, 25% in 2 years … etc. At the time of vesting, the company buys a share, and gives it to you. In this way, it is much like a cash bonus. And like cash bonuses, the company will withhold taxes at that time of vesting (commonly, they will just keep shares from your award).
For example, you just received 100 RSU’s that have vested. The company stock is $1. You will received 100 shares of your company at $1 = $100 of compensation. Assuming you are in a 25% tax bracket, the company will hold 25 of your shares. Which means you net out 75 shares.
What do you do with an RSU?
You have 2 options with RSU’s … you can either sell them immediately or hold them. If you sell them immediately, since you just paid the taxes on them, and they likely have not appreciated much, you will not have to pay any capital gains taxes, and you will just receive the cash. if you decide to hold them, and they appreciate, then you will have to pay the capital gains on them.
One major advantage of RSUs
They almost always have value, even if the price of the stock has dropped. For the certainty of that value, RSU are commonly deemed more valuable than stock options. Which brings us to …
What is a stock option?
A stock option, gives the holder the right to purchase a stock in the future at a predetermined price. Like RSUs, options are given out as performance incentives, and typically have a vesting period.
For example, you have the option to purchase your company stock in 1 year’s time at $1. If the stock goes up $1.50, then it would make sense for you to purchase the option at $1, because you would have a built in .50 return. If the stock dropped to $.90, you would not exercise the option, b/c you would be better off to buy it on the market for $.90 than through your options at $1.
**Note that exercising the option is a purchase, but not a sale. Which means that you will not pay any taxes at the point of the exercise. You will only pay taxes upon your sale of the stock.
What do you do with an option?
You should have no more than 5% of your portfolio in single stock.
You can either sell it immediately and pay the capital gains equal to difference b/w the current price and the price at exercise. Or you can hold it. There are advantages to holding it for greater than a year, since you will pay the long term capital gains tax (as opposed to short term capital gains, assessed at your ordinary tax rate).
Advantages of options
You have greater control over taxes with options, since you decide when to sell them (and thus when to pay taxes on them). And since they are riskier, companies typically give you more options.
How do options and RSUs play into your overall portfolio?
Most people just let both their RSU’s and options sit and collect over time. They don’t manage them, they don’t sell them, they don’t really think about them until they move to another company, or they grow big enough to force a conversation. This is a BIG problem. From a simple portfolio diversification perspective, you should have no more than 5% in single stock. And your vested options/RSUs are part of your portfolio. If you have 100k sitting in RSU’s or options from your company, you are very likely way over-allocated. Second, you already have plenty of exposure to the results of the company. Just check your bank account every other week, who is making auto deposits?
If you have “new” RSUs just sell them, you won’t (likely) have to deal with any major tax consequences. If you have older RSUs then you will need to check for capital gains exposure, and make sure you factor that into your savings for next year. Since you had to exercise your options, that means, that very likely you have some major capital gains exposure. So beware, when you sell them.
After selling them, increment into a low cost ETF, rinse and repeat next year.
How and When to Invest in an IPO
There are plenty of IPO investing opportunities on the horizon, use my strategy to avoid the pitfalls.
2019 is primed to be a very compelling year for initial public offerings (IPOs) for interesting companies. We are about to have a whole cast of new unicorns entering the prime grazing ground of the US markets. There are plenty of opportunities to get involved, as well as pitfalls you should be aware of. You have likely heard of recent newcomers including:
Lyft (LYFT), the new age transportation (taxi?) company
Pinterest (PINS), a next generation sales and marketing platform
ZOOM (ZM), a new comer to video conferencing world, with a killer application
BEYONDMEAT (BYND), pushing the boundaries, providing a better way to feed the planet
As well as a few big ones, yet to come:
In complete transparency
I own a number of stocks discussed in this article: LYFT, PINS, AMZN, and FB.
Uber, the ride hailing company, looking to push into autonomous driving, food delivery, smart cities and more.
Slack, the future of business communication: beyond email
Here is the thing, about IPOs:
IPOs are RISKY!
If you buy on the opening day, you only “think” you are getting in early. Most of the “early” shares are allocated to big players.
You may think that you understand the business model, and the goals of the company. But often the long term strategy has not been fully vetted (think Amazon coming out as an online book store, Google as a hopped up search engine and Facebook as a way for college students to connect). Or the long term strategy has not been fully broadcast and understood.
The real numbers behind the business, while private, have not been fully vetted by the market at large.
There are just as many examples of short term flame outs, after IPOs, as there are successes. Recent examples include:
lyft - down from high $80’s to low $60’s in the first month;
Spotify - launched in May 2018 at around $160 and is now at $136;
Remember Facebook’s bumpy first year? It launched in May 2012 at $38 and closed one year later $27.50.
But there are wonderful opportunities in buying stocks of companies at an early point and then holding them for the long term.
Nobody, still holding FB, from the beginning, is fretting about the first year decline, given the current price of $195. Nor are people worried about Amazon starting at $18, now worth $1,900.
The best long term strategy for building wealth is
to invest in a few widely diversified, low cost ETFs.
So how do you approach this delicate situation?
First Know this: The best long term strategy for building wealth, is to invest in a few widely diversified, low cost ETFs. Then continue to buy through the short term, ups and downs of the market.
If your risk tolerance is low, stay away.
Wait until things shake out over the course of the first year or so. This will give analysts the opportunity to dig through the numbers, the business strategy and company leadership. These stocks will also end up in your broad based ETFs. So don’t worry, you will gain exposure.
If your risk tolerance is high,
meaning you can deal with wild swings, you can afford to risk a total collapse in the company and you have some money not currently allocated to your long term goals. I believe there is a way to tip toe into the situation.
How to determine if you should invest in an IPO
You need to have a strong conviction in the company’s business strategy. For example, you believe that meat production, on a world wide scale, is going to lead to a long term detrimental impact to the Earth. And you believe over time, that people will become more open to alternative sources of protein, then BYND may tick this box for you.
You need to have a long time horizon, for the market to completely factor in all of the unknown variables into your company. In the short term, these stocks are going to trade wildly. And are actually a perfect example of how irrational the market is SHORT TERM. For example, it is inexplicable why lyft traded between $58 and $62 last week … there has been NO real new data, at all.
You need to determine how much of your portfolio you are willing to BET on this strategy. You should be thinking < 1%.
You need to have an entry and exit strategy for buying/selling the stock.
How I Invest in IPOs
I buy 1/3 of my allocation, based on #3 above, at the end of the first trading day. NOT at the beginning. The bid/ask will be too wide early, with all of the jockeying. By the end of the day, the day traders looking to cash in on the first day volatility, will be ready to sell. So around 3:30pm, put in a buy order.
Sit tight for, either some set time frame (2 - 5 months), or until there is a major slide in the stock. Many times, reality will set in, people will come to understand that they need to gather some additional information on the company. At that point, the stock will take a breather and potentially drop 10-25%. If that happens, buy 1/3. If the stock goes up or trades side ways, just plan to buy at a set future date.
Set a third time frame, well into the future, like 1 or 2 years. This will have allowed all of the institutional/inside money to exit after the lock up period has expired. And there will have been several quarters of legit reports, that can be used to determine just how serious the company is. Buy your final 1/3 at that date.
Buy and hold. If you believe that the company has a good strategy, and is in a growing market, and has good leadership, your holding period should be indefinite.
When to Sell
Each year, when evaluating your asset allocations, it is a good time to consider how this investment is playing out. Sell if the stock has appreciated and is now a much higher percentage of your overall portfolio, than makes sense.
Sell if the company has taken a strategic direction that is different than your original understanding.
Sell if the company leadership proves unable to keep up with the challenge.
Sell at some set date into the future.
Sell if the stock reaches some percentage of gain/loss, that you are happy/unhappy to have achieved.
If you have a plan, your outcomes will be set and understood, and you will have an opportunity to take the emotion out of this investment.
*** Please, Please PLEASE, don’t check this stock on a daily or weekly basis. The more you check it out, the more likely you will be to get emotional and make a decision counter to your above strategy.
Questions? If you want to talk more, drop me a line, I am happy to provide further clarifications.