The 5 Biggest Financial Planning Mistakes Made by Tech Professionals | Mistake #2

I love working with the tech community. I started my career at Microsoft and have since been inspired by the creative and innovative minds of folks working at tech companies large and small. I also enjoy working with tech employees, because as a personal finance nerd, I get to help people navigate the plethora of benefits available that are often only available at tech companies. Between RSUs, ESPP, Non-Qualified or Incentive Stock Options, Mega Backdoor Roth 401(k)s, Deferred Compensation, Legal Services, and even Pet Insurance, it is the benefits equivalent of picking from a menu of a Michelin three-star-rated restaurant.

Through my own experience as a tech employee and my experiences now as an advisor working with tech professionals, I’ve identified some of the biggest financial planning mistakes that can hold the tech community back from achieving financial independence and success.

Mistake #2 – Building and Maintaining Concentrated Stock Positions

I consider a concentrated position to be any investment that comprises over a quarter of your investable assets. It can be easy to accumulate a concentrated stock position in the same company that is responsible for your paycheck. If you receive stock as part of your compensation, without a disciplined plan to sell shares on an ongoing basis, you will continue to accumulate more and more company stock. Over the past several years, countless families have become wealthy because of the stock compensation they’ve received and its seemingly never-ending climb in price. While the strategy of holding onto RSUs and ESPP over the recent past has worked out incredibly well, we know that continuing to maintain a concentrated stock position is incredibly risky if you want to ensure you maintain your newly built wealth.

There are two explanations for not reducing a concentrated position that I hear most often: (1) My company has outperformed the rest of the market several years in a row. If I believe in my company and our growth prospects for the future, why would I sell? (2) If I sell my company stock now, I’ll have to pay a significant amount of tax on the gain. Let’s debunk each of these as reasons not to diversify:

(1) Typically, returns of a single stock position are intensely more volatile than the returns of a market index. This can work out in your favor, or it can work to your detriment. Historically, about 12% of stocks result in a 100% loss.* In addition, approximately 40% of stocks end up with negative lifetime returns, and the median stock underperformed the market by greater than 50%.* This means that a few star performers drive the positive average returns of the market. The odds of randomly picking one of these extreme winners is 1 in 15.* If you’ve been lucky enough to hold one of these outperformers, I encourage some humility around acknowledging that maybe being in the right place at the right time has attributed to your rapid accumulation of wealth.

Companies that achieve such success and become the largest company in their sector may become subject to what is called the winner’s curse. Since the 1970s, data shows that sector leaders underperform their sector by 30% in the five years after becoming the largest company in that sector.* Over a long time horizon, you are probably more likely to obtain positive investment returns by ensuring you hold the future Microsofts and Amazons of the world through broad diversification, not concentration.

(2) I hate to tell you this, but unless you hold onto an investment until you die, you will have to pay tax on the growth at some point. I encourage people to think of paying long-term capital gains taxes as a good thing, because it means your investments went up and you made money. A surprisingly small fluctuation in stock price can wipe out any benefit of delaying the recognition of capital gains tax. As advisors like to say, “Don’t let the tax tail wag the dog.” If you’d like to discuss your situation, don’t hesitate to contact me.

Be sure to read our previous and upcoming blog posts for additional mistakes to avoid as a tech professional.

Source: * Avoid Gambler’s Ruin: Bridging Concentrated Stock and Diversification

Disclosure: The material is presented solely for information purposes and has been gathered from sources believed to be reliable, however Merriman cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. Merriman does not provide tax, legal or accounting advice, and nothing contained in these materials should be relied upon as such.