I regret to say I didn’t participate in my employer’s pension plan. However, I did join the employee savings plan – now called employee stock purchase plans. The resulting investment eventually became the backbone of my retirement plan.
Many employers have stock plans that allow their employees to purchase shares in the company at a reduced rate. Employee stock purchase plans, or ESPPs are a great forced savings method and a way to purchase stock at a bargain. Your bosses are hoping that by having a stake in the company, you’ll work harder, increase profits, and keep the stock price soaring.
How do Employee Stock Purchase Plans work?
For whatever reason, some people who work for companies with stock purchase plans don’t take part in them. They may feel they can’t afford to, or are reluctant because they don’t fully understand how they work.
In general, an ESPP lets you set aside a percentage of your pay to buy stock of the company you work for. This amount is used to buy shares at market value every pay period – most companies even offer them at a discount. Your contributions may be matched in part (mine was 50%), or in full by your employer. They are incentives for employees to participate in the plan.
Other advantages are:
- the purchases are not subject to transaction costs
- dividends are automatically reinvested
- buying the stock frequently gives you the advantage of dollar-cost averaging
The employer matched amount, as well as the discount (the difference between the offering and market value), are fully taxable to you as an employee benefit.
Building your long-term portfolio
I was able to transfer the vested stock directly into my Self-Directed RRSP account. I definitely became over-weighted in bank stock, but the accumulated dividends purchased other investments over time.
Be cautious about overloading on company stock if you are building your retirement savings this way. At some point you must diversify. Putting all your eggs into this one financial basket could have serious future consequences.
How would you feel if your company’s share price starts decreasing? Would you feel concern about your overall employment security? Your paycheque already depends on the financial health of your employer. It’s too risky to have the majority of your portfolio riding on the same place your paycheque is coming from.
If your company performs badly you could lose both your income source and your investment value. Not likely, you say. That was also the opinion of the employees of Nortel, Enron, and US K-Mart until they saw their investments dwindle to next to nothing.
How much should you hold? It depends on your company – a financial institution vs a start-up software company, for example.
In any case, it’s a good idea to limit your single stock holding to not more than 30%. So, as your holdings increase, sell some company stock and put the money into other investment vehicles.
I’m just going to sell the stock
Many of these plans will allow you to cash in your shares at any time, others allow you to cash in after a set period, such as one year.
Hopefully, over the course of the year the stock will increase in value, but even if it doesn’t, you will be buying the stock frequently, possibly giving you a lower average cost than if you’d made one lump-sum purchase. Of course, the stock price could drop as well, but even if it does, you would be buying stock at the reduced price plus have company matching.
A few of my colleagues immediately sold their shares as soon as the vesting period ended. Even after paying taxes, with the discounted price and employer matching I would think that they most likely sold at a profit.
So, the ESPP can still work for you if you use the sale proceeds to invest elsewhere, or even use it to pay down debt.
It’s always a good idea to take advantage of any offering by your employer that will increase your wealth. An Employee Stock Purchase Plan with a discount can be a great employee benefit. It’s a good way for young people – even those with part-time jobs – to start investing.
It can be the first step in developing a diversified portfolio. But, make sure you do diversify.
Have you considered owning stock in the company where you work?