Four Considerations When Diversifying Your Portfolio

As part of an overall pay and benefits package, equity compensation can deliver a key benefit: the ability to acquire company shares at a discount or no cost. There are three common types of equity compensation: stock options, restricted stock units (RSUs) and employee stock purchase plans (ESPPs).

As you accumulate company stock, you may find that it represents a sizeable portion of your total portfolio and net worth. But investments can fluctuate in value based on market conditions, company performance, geopolitical factors and more. If you have too much of your portfolio invested in a single stock and that stock loses significant value, your net worth can take a major hit.

So if you hold company equity, it’s a good idea to assess your holdings in light of your risk tolerance and financial goals. You may find that you need to take action to diversify your assets and protect your wealth. 

Four Essential Questions as You Consider Diversifying Your Holdings

1.   What is the value of my equity awards?

The first step in understanding whether you may need to adjust your portfolio is to calculate the value of your equity compensation. Here’s how:

Remember, whatever type of equity you have, there could be tax implications at conversion (RSUs), exercise (stock options) or sale (all types of holdings)—be sure to understand the tax impacts at different stages of your equity’s life. While the taxes, commissions and fees due on your equity holdings don’t impact the value of your shares, they will impact the amount of net proceeds you have access to. 

2. What is the value of my overall holdings?

Once you’ve estimated the value of your equity compensation, the next important step is to determine the value of your total financial holdings, or net worth. This can include assets in investment portfolios, trusts, savings and checking accounts, retirement savings accounts and real estate, to name a few.

Once you know the approximate value of your overall holdings, determine what portion is comprised of company stock. Don’t forget to include any shares that may be in your 401(k) or other investment accounts, as all of them count toward the total amount of company stock you hold.

How does this look in action? Let’s say Denise currently holds $100,000 in vested and unvested shares of her company’s stock, plus $10,000 worth of company stock in her 401(k), for a total of $110,000. When she calculates her total financial holdings, she values them at $500,000. That means that on a gross basis, 22% of her portfolio is held in company stock. 

3. Am I over-concentrated? Do I need to consider diversifying my assets to help protect myself against risk? 

Once you complete your calculations, you’ll want to assess whether your concentration in company stock is in line with your goals and risk tolerance. If the total amount of company stock you hold represents more than 25% of your net worth, you may want to consider diversifying your portfolio.¹

4. How can I diversify?

One simple way to reduce the percentage of your equity holdings is to sell some of your shares, making company stock a smaller percentage of your overall holdings. But remember, if you sell stock, you may owe capital gains taxes or transaction fees. Be sure to consult a tax professional to understand the impact of a sale.

Another strategy is to expand your financial portfolio to make company equity a smaller portion. In volatile markets, some assets may underperform while others perform well, so investing in a range of companies and asset classes may help reduce risk. Investment solutions like exchange-traded funds (ETFs) or mutual funds can provide instant diversification because they invest in multiple companies at once. You might also consider investing in causes meaningful to you if they fit with your financial goals.

Don’t forget to ensure your retirement portfolio is diversified, too. As we saw in the example of Denise above, your 401(k) may also be partially invested in company stock, which could lead to over-concentration when valued alongside equity compensation or outside holdings. If you need help developing an asset allocation strategy, talk to your retirement plan provider.

Start Now—But Take Your Time

It’s natural to feel a little overwhelmed about creating a balanced financial portfolio. Take it step by step and remember that there are professionals, like Financial Advisors and tax advisors, available to help along the way.

Remember that your equity compensation provides an exciting opportunity to help build your wealth but must be considered in light of your overall financial picture. As your portfolio grows, revisit it regularly to determine how much of your net worth is invested in your company and, if necessary, make changes to help ensure your portfolio is properly diversified. 

Footnotes

¹Michael Beriss, “Top 10 Financial-Planning Rules Everyone With Stock Options Needs To Know,” mystockoptions.com. Accessed May 17, 2024. This number could be higher or lower depending on your financial strategy, so you may want to speak with a Financial Advisor for insights on your specific situation.