Stock options can provide a platform for building wealth. But, mismanaging them can put you in a challenging financial situation. The best course of action is establishing a plan so you can make smart decisions and avoid costly mistakes. With this in mind, here is a list of the most common stock option pitfalls when dealing with employee stock options.
Not Understanding Employer Stock Compensation and Incentives
While this may not come as a surprise, many employees don’t read the fine print of their stock plan agreements. So, before you do anything else, take a moment to review these documents and familiarize yourself with the type of grants you received and applicable rules.
Not Exercising Stock Options Before Expiration Date
Stock options have an expiration date, and this date may be adjusted in the event you separate from service. This means that if you wait until after the expiration date, your stock options cannot be exercised, effectively rendering them worthless. Pinpointing a timeline can help you make a plan, so you’re not scrambling to exercise your shares at the last minute.
Not Planning for Stock Plan Related Taxes
Before deciding how and when to exercise your stock options, you must understand each decision’s tax implications. Taxes can impact the profitability of stock options. It’s possible the stock price moves downward quickly, and you may be forced to sell stock at a loss in order to cover tax obligations in the future.
However, taxes alone shouldn’t drive your decision making. It would help to align your strategy for dealing with employer stock with your financial goals and objectives. It’s wise to model tax situations so you can prepare in advance. For example, often, employers don’t withhold enough taxes when you exercise your options. Consider setting aside additional funds to pay your remaining tax bill.
Holding Too Much of Your Net Worth in Employer Stock
Another one of the stock option pitfalls is holding too much of your net worth in stock options. You may have a personal connection with your company’s stock as an employee. You believe in your work and your mission, so you’re optimistic about the stock value climbing the longer you hold onto it. It may also be that over your entire tenure it only seems the stock price of your company continues to climb.
Regardless of the size or success of a company, it presents more risk to your overall financial situation if you choose to hold a higher percentage of your net worth concentrated in one stock.
It’s possible that one day, having too much of your portfolio tied up in your company’s stock may become more of a curse than a blessing.
Consider diversifying across different investments and asset classes over time. After all, it’s unlikely that a single company will outperform all other investments consistently over time.
While your company might not see a total collapse in share value, economic and market events can impact a single stock more than others. Your portfolio and income could see significant fluctuations that make it challenging to plan for your future.
Not Understanding What Happens to Your Shares When the Company Gets Acquired
It’s possible your company may get acquired. So, where does an acquisition leave your stock options? Well, it depends on the negotiations between both companies during the acquisition. Some outcomes may include
- Shorten the vesting schedule and expiration date, therefore you must exercise your stock options all at once
- Substitute your stock options for a cashless exercise
- Exchange stock option shares for shares of the company acquiring your company
- Receive a combination of cash and stock with a new vesting schedule
- Receive a cash payout for all of your vested and unvested option or shares
No matter which option your employer goes with, it’s essential to research, so you know how to maximize your benefits. Better yet, speak with a financial planner who can help you navigate stock option decisions. This way, you can side-step these stock option pitfalls while building your wealth for your future.