How To Diversify Employer Stock – 3 Step Approach

We all know the importance and benefits of diversification. However, if part of your comp package includes employer stock (RSU’s, ESOP’s, ESPP etc.) finding balance in your portfolio can prove to be difficult.

Equity compensation can heavily tip the scales to one side. Throw in the fact that part, if not all, of your household finances depend on a specific industry and things can get real dicey. So how do you round things out? Start by lifting the hood on your investments and take things apart.

1. Do A Deep Dive

The above graphic is the popular S&P 500 index (also a popular holding for many folks out there) broken down by individual sectors. Based on recent market trends, the tech sector is also its largest constituent, making up roughly roughly 27-28% of the index.

For the sake of argument (and simplicity), let’s say you’ve worked in tech for the last 15 years and are granted 100 shares of company stock per year as part of your comp package. Let’s also assume that your 401k is invested in a series of funds: stocks and bonds both domestic and international. Buying and investing in an S&P 500 fund may offer diversification at first glance, but taking into account the years of accumulated equity comp can tell a different story.

The graphic below shows the comparison of what your portfolio may look like under normal circumstances (left hand side) versus what it may look like when you tally in your employer stock (right hand side). All of a sudden your actual allocation to tech jumps from 27% to 38%.

The “Sample Investor Portfolio” chart on the left uses data derived from SP Global. The chart titled “Sample Investor Portfolio with Equity Compensation” is for illustrative purposes only and assumes the client has equity compensation derived from the tech sector.

2. Deconstruct and Reconstruct Your Portfolio

Recent product innovations have given investors a variety of ways to put together a diversified portfolio. There’s a fund for just about anything! Rather than trying to make things too complex, one way of rounding out your allocation is to purchase funds that represent the individual sectors of the index you’re trying to replicate.

Using the same example as above, any number of fund companies offer sector specific (but still diversified) funds. Essentially you are putting the puzzle back together, sector by sector, until the picture is complete.

For example, an investor could purchase 10.4% of their portfolio in a financial sector fund, 13.7% in a healthcare fund, and so forth until they reach the sector they’re over exposed to.

3. Building Around Your Industry

Using the same example, if you happen to work for one of the more popular tech companies, the above can be relatively easy. In an ideal world, you would ensure your employer stock makes up no more (and ideally substantially less) than your industry’s allocation in the index. If you have room leftover you could purchase the sector fund to round out the allocation.

For example, if your employer stock accounts for roughly 10% of the required 27% – one could purchase the remaining 17% in a tech sector fund. It may not be 100% representative of the index, but it’s an easy solution that won’t leave you pulling your hair out.

If you don’t happen to work for one of the larger tech giants, and instead work for a smaller niche within that industry, finding your balance can be a bit more complex but still achievable.

The same rules above apply, they just may require a little more research on which investments you can use. Again, recent product innovations have made it so that there is literally a fund for just about anything. Having an identical replica of the index is not as important as taking steps towards diversification. Accuracy can be obtained over time.

The above is only an example of one such solution – several others exist. While it’s not a perfect match as you’re still taking on some concentration risk, it’s a step in the right direction. There are also more nuances to consider: vesting requirements, taxes, whether to exercise or not, etc. amongst others. Need help? Click here.

1. The information above was derived from S & P Global: https://www.spglobal.com/en/.