How Much Should I Contribute to My Company’s ESPP?

Let’s start off by deciphering yet another investment acronym, ESPP, Employee Stock Purchase Plan. This is a company-sponsored program that allows employees to purchase shares of the company stock at a discount. Typical discounts offered might be in the range of 5% – 15%. It sounds enticing, but is the juice worth the squeeze?

Why Do Companies Offer ESPP Programs?

Let’s reflect on why companies want to encourage employees to purchase stock in their own company. It promotes company loyalty, drive towards a common goal, and a sense of ownership and engagement. That’s a win for the company. On the other hand, the company must give up its shares at a discount to make it attractive for the employees to purchase, so that’s a bit telling. A discount on share price is nice, but it’s not everything.

The Risk of Over-Reliance on Your Company

Think about how much you already have riding on your company. You receive your paycheck via direct deposit periodically like clockwork. You typically have vacation or sick leave time at your disposal. Your health insurance is greatly subsidized by your employer. You likely have other benefits like group life insurance, short-term and/or long-term disability insurance, perhaps even stock options, restricted stock units, or performance shares that are granted. It’s an easy case to make that the last thing you need to add to your portfolio is more reliance on your company in the form of company stock.

The Case for Diversification Over Concentration

Alternatively, excess funds that have been directed into an ESPP program could be redirected into a taxable account and invested into a basket of low-cost, diversified ETFs. Instead of placing all your eggs in the company’s basket, spread out the risk over literally thousands of companies. Then it won’t matter if your company’s stock price stays flat or even declines for several years, as you rise with the market while invested in diversified funds rather than one concentrated stock position.

Tax Considerations with ESPP

Even if you believe in your company and the discounted purchase price is too good to pass up, beware of the tax consequences that a quick purchase and sale strategy brings. If you hold the shares for less than 12 months from the purchase date, the appreciation is taxed at ordinary income tax rates. That can eat into a 5-15% discount quickly. Shares held longer than one year have gains taxed at long-term capital gains rates. Again, you need to weigh the risk of owning a concentrated position and the burden of making the associated purchase and sale transactions and tax reporting with any residual after-tax benefit to decide if the concentration risk is worth the effort.

Is an ESPP Right for You?

If you have all other savings areas covered (emergency savings, retirement, education), still have excess cash to invest, think the company stock is on a positive trajectory, and have the time and discipline to track the ESPP purchase and sales, consider allocating a small percentage into the plan to take advantage of the purchase price discount. Otherwise, you’re not missing much. A diversified portfolio is a better long-term play than a company ESPP.

Have questions? Feel free to contact us.