RSUs make up a large portion of compensation for a lot of employees. If you're receiving RSUs, you should understand the implications of when you sell.
If you work for a public tech company, chances are part of your compensation will come in the form of RSUs, or Restricted Stock Units. One question you might have as an employee receiving RSUs is: when is the best time to sell them?
It's widely acknowledged that if your company is public, you should sell your RSUs as soon as they vest.
This article will explain both RSUs and vesting in more detail, describe the benefits of selling your RSUs as they vest, explain the importance of diversification, and give real-world examples of why holding onto RSUs will likely not benefit you in the long run.
RSUs are a type of equity compensation issued by an employer to an employee in the form of company shares. Unlike ordinary stock options, if you are granted RSUs, you own company shares without putting your own money into the company.
RSUs are issued through a vesting plan (more on that later) after you achieve required performance milestones or after working for your employer for a set length of time.
There is no tangible value in RSUs until after the vesting period is complete, which is when they are assigned a fair market value (FMV), or the price that an asset would sell for on the open market. After that point, RSUs are considered income and a portion of the shares will be used to pay income taxes. However, the remaining shares are given to the employee to sell.
Your RSUs will vest over time according to a vesting schedule. Simply put, vesting means the shares become yours, and the vesting schedule is just the timeline over which you earn them.
What do vesting schedules look like? Typically, RSU grants that are part of compensation packages are subject to 4-year vesting schedules. The number of RSUs that you receive in each of these years differs by company. Employers issue shares in this way to incentivize you to stay at the company for multiple years.
Vesting RSUs gradually transfer shares to an employee and make them invested in their company’s success. You cannot sell RSUs until after they vest, but when is the most beneficial time to sell them? Should you hold onto them after the vesting period ends?
Most experts would advise you to sell your RSUs as soon as they vest at a public company (RSUs work very differently at private companies; read about them here). RSUs function like a cash bonus, which means they are taxed as ordinary income in the same year that they vest.
It can be more beneficial to use RSUs to either meet short-term goals or to reinvest the money into a diversified portfolio. It’s a low-risk maneuver to sell as soon as they vest because an RSU always has value. However, the longer you hold on to the RSU after the vesting period, the more you risk that it will fall in value.
There’s no tax advantage to holding onto RSUs, and diversified investments perform better than investments concentrated in one stock, even if that stock is your company. The longer you hold onto RSUs, your net worth becomes more and more concentrated on a single stock, leaving you vulnerable to that single stock's volatility.
Keeping all of your stock in one place is inherently risky, even if you work for a massive company like Google or Facebook. You never know when a single stock will plummet, so it’s smart business to diversify instead.
In addition to a lack of diversification, here are some other reasons why holding your RSUs is not the best decision:
There are some reasons why you might want to hold onto RSUs, but they are uncommon and much riskier than selling them right away. If you have good reason to think that your company share value will increase in time, you might want to hold onto your RSUs. However, this is unlikely to be more lucrative than reinvesting in a diversified portfolio.
If you hold onto your RSUs after the vesting period ends, you have a concentrated equity position as opposed to a diversified portfolio. A concentrated position is generally defined as a single stock that makes up more than 10% of your investments.
Why is a concentrated position risky?
This is inherently risky because a large portion of your finances will be tied to a single stock. So, if the stock becomes volatile and its price drops, you could lose a lot of money. In a market environment where volatility is the rule rather than the exception, owning a concentrated equity position is inherently risky.
How does diversification reduce your risk?
Diversification reduces a portfolio’s overall volatility by spreading risk exposure and return opportunities across multiple industries and asset classes. So, if a single stock experiences volatility, you probably won't be affected that much because your portfolio will be balanced out by your other holdings.
In particular, diversification can help reduce two major types of risk: company-specific risk and macroeconomic risk, which is risk spread across industries, such as a change in unemployment, inflation, GDP growth, or a global pandemic.
If you have a concentrated equity position, you also run the risk of not having the liquidity needed to pay your expenses, as all of your money is tied up in the same company. Diversification prevents this and also helps you reinvest in assets that could produce even more income.
In conclusion: diversify!
Selling RSUs immediately and investing in a wide range of asset classes such as stocks and bonds is a relatively simple, straightforward strategy that minimizes your risks and maximizes potential rewards. Regardless of what you choose to do, plan your strategy carefully with your financial advisors and figure out the best way to diversify.
The higher percentage that RSUs make up in your investment portfolio and total net worth, the more likely it is that you will want to sell them as soon as they vest. If your company performs poorly and your RSUs are a significant percentage ratio of your net worth, your financial assets will be substantially reduced.
The COVID-19 pandemic had a major impact on financial markets and stock prices; while some tech companies soared during 2020, others reached historic lows. Either way, the market was extremely volatile and unpredictable, leading the financial industry to question incentive compensation.
A decreased share price means that share units are not incentivizing overall for employees, so incentive compensation might have to change in the wake of the global pandemic. Some employers may consider alternatives for compensation plans that don’t just retain employees for longer, but also make sure executives are not benefitting from the pandemic while employees suffer.
The Washington Post reported that even though the largest American companies turned a profit in 2020, the majority cut their staff and gave the profits to shareholders instead. For employers who held RSUs, the pandemic ensured that they would not see the profits they might have seen if they had sold them off beforehand.
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