Your Company Stock Is Up. What Happens If You're Wrong? | Concentrated Equity for Executives

Here's a question most financial advisors won't ask you when your company stock is up. What happens if you're wrong? Not about the company, but about the timing, about the window, about the thing you didn't see coming. That's what Nolan and I want to talk about today.

Yeah, you're right, Brian. The executives who end up in the most difficult financial positions, they aren't the ones who made bad decisions. They're the ones who made no decision. While the stock was up, while everything felt fine, while there was still time to act.

If you've got a concentrated position and you've been telling yourself you'll deal with it later, this is the video that makes later feel a lot closer. Let's get into it. So a quick introduction before we get started. I'm Brian Dress, director of research at Left Brain and also an advisor. We're an independent wealth management firm based in Naperville, Illinois. We specialize with working with corporate executives on exactly the situations that we're covering today. With me as always is our CEO and Chief Investment Officer, Nolan Langford. Nolan, welcome to the program.

Thank you, Brian.

For those who haven't seen us before, give people a sense of what we do here.

Well, my background is in fundamental research, deep single company analysis, and that research lens is what we bring to every client situation we work.

Excellent. And today we're talking about what you do when your company's stock has appreciated significantly and it becomes a large, maybe very large part of your net worth. We're going to cover the math that most people don't know, the real risk of just holding, and the framework for thinking about it clearly. If this is the kind of content that's useful to you, click subscribe. We put this out regularly and it's always free.

Yeah, a lot of executives have significant equity packages and have genuinely never had someone walk them through the full picture. Not just what the grant says, but what it's actually worth, what the tax exposure is, and what percentage of their net worth is riding on, uh, is riding on one name. How often do we see that gap?

Exactly, Nolan. So this is something we see a lot. There are a lot of executives out there with company stock. In this particular case that we're discussing today, things are going really well with the stock. And so sometimes it feels like you can do no wrong with that stock. So talk to us about, um, some of, some of the pitfalls that might befall you if you're in that situation.

And it's natural to be in this situation. If it's not broke, why would I fix it?

Exactly.

How many times do we hear people say, well, things are going well, so I want to leave that alone?

Exactly. And unfortunately, there's a big graveyard of stocks like that over the years. So we want to talk to people to make sure that they don't get into that situation where they're doing well one year and then 10 years down the line, you know, what they have is worthless.

And we see that often, you know, stocks tend to do well until they don't. And, you know, we always say it's the escalator up, the elevator down.

Right.

So a lot of clients get comfortable. A lot of executives, they get these grants, they get these shares issued every year. They sit in a corporate meeting. So they hear corporate strategy, they quote unquote, drink this Kool-Aid. And then when they look at their statement and their stock values are going up, that kind of reinforces. Right. And so at that point, it's hard to be skeptical, but you need an independent analysis to take stock, particularly when that stock value starts to creep up in your net worth statement. Right. And it starts to dominate the value of the household net worth.

Exactly. So that's what we're talking about today. You work at a company, you draw a paycheck from that company. You also have shares in that company and it becomes, you know, 40, 50, 60, 70% of your net worth. That's where we think there's something, a challenge to solve there. So we're going to talk about that today. Let's make it concrete for people. Nolan, walk me through what it looks like when someone actually sees the full picture for the first time. So obviously a lot of times what happens is, okay, I know I've got stock coming in, but there are a lot of different aspects to it. There's the total number, how much of my net worth is that, the tax exposure, your concentration. So what happens when people first kind of become first start to come to grips with that? How does that conversation go?

Usually they're somewhat a little bit surprised. You know, a lot of people don't think necessarily holistically. It's in a vacuum. I've got— I've received these stock grants, the stock's going up, and on paper I've got $1 million, $2 million, $5 million, pick the number. But you're right, when you put it all together, the restricted stock options, the employee stock purchase plan, their deferred comp, their 401, you put the total household net worth on a paper. And a lot of times that number surprises them. And that's the denominator. But when the numerator is how much of that net worth is specifically in this one company stock, right? That's when it illuminates and it starts to really ring people's bell.

So we got to bring back fractions here and talk about what fraction of your net worth is in this one security. And there's definitely some, some peril in that. Yes.

Absolutely. And on the upside, let's talk about the good stuff. You know, the stock market's been doing well. I think we're going to continue to do well for the next couple few years on the index level. Underneath the index, the individual securities, it can be a wide range of outcomes.

Yes.

And so it's easy kind of to get lulled to sleep to think, okay, you know, my net worth is going up, everything is fine. But it's when the skies are sunny that we need to think about an umbrella. Okay.

And then let's— we're kind of talking a lot of times with executives. They come in to talk to us for the first time, first time they're thinking about these things. At this point in the conversation, what's the first thing you actually recommend someone to do with the information that we just mentioned? You know, that question of how much of your net worth is really in one security?

We need to think about a plan. You know, a lot of these securities, again, security prices are unpredictable. They trend up over time, but like we mentioned, there's a wide range of outcomes. I mean, the graveyard is littered with companies that were once successful that no longer are. So the first thing that we need to think about is what is our comfort level? Hey, if this security makes up 50, 60% of my portfolio and it dropped by half, would that impact my standard of living today? Would it impact my retirement plans tomorrow? Okay. So I think that's the first sort of exercise that we need to go through to actually see risk tolerance and how this would impact somebody if things went the other way.

So stress testing for some different scenarios kind of brings it into focus of what we're facing here.

Correct. And that would be more qualitative. You know, that's kind of how I feel. It's personality-based. And then there are some quantitative things that we need to think about as well. So taxes, you know, what happens to me in a tax situation? You know, sometimes these shares were given to me and I pay taxes up front. And if they keep going up, that's one thing. But if I pay taxes up front and now the shares actually fall, and if they end up in a loss position, but I've already paid taxes on them, that could be hurting proposition. We really need to be careful about not only taxes, but also our concentration. And then the other thing, Brian, is our opportunity cost. Yes, these shares of the company that I work for are going up, but we need to think about the alternative. You know, could I do better for myself if I diversified into owning some other businesses that are also likely to go up, saving myself some risk, but also maybe preserving my values even on the upside?

Okay, so we're going to talk about all that today. And then there's actually another video where we're going to talk about about kind of that other scenario you mentioned, which was that the stock is down. But if that all landed for you and you haven't really thought about what percentage of your net worth is tied up in one stock, if you own company shares, do me a favor and hit like. It tells us that it's worth us going deeper on this concept. It helps us to get more this content in front of more executives who need it. So if you know of someone that this applies to, share it with them, okay? And then we're going to keep going. So let's talk about what could go wrong, the moment that everything goes wrong. So Nolan, I want to just paint a picture for you because concentration risk is what we're talking about here. And it's something that executives understand intellectually. We can discuss this on an intellectual level, but if it actually happens to you, that's a totally different situation. So you've been in this business and you've worked with many executives that are in this situation. So walk me through that moment where, what it actually looks like when things do go wrong.

It's not a pretty picture. We've seen a number of big companies here who were formerly, you know, Fortune 500 companies that are not around anymore, at least not in as good a shape. Let's take the case of Walgreens, which for many generations was a blue chip stock. I mean, you could just set your watch to how well the stock performed. And you're right, executives here, they're headquartered here, were just very comfortable holding the stock and Yeah, I think usually these stocks go the other way in stages. It's not very often that you wake up one day and somebody went from hero to zero.

Right.

It usually happens on the way down. So you asked about the executives, what their response is, and they usually go through the stages of grief, disbelief, denial. It can't keep going down. I just sat in a meeting. I hear our strategy. You know, Wall Street, they don't understand, other investors don't get it. And what's really devastating, Brian, is not just the company executives own the company stock, you know, they work there, right? So you get their paycheck there, their retirement plan is based there, uh, they have shares that are there, they have friends that are there, and their identity is tied up into this business. So it's not an easy thing. I, I really, you know, I kind of do feel for them. But it's devastating when things go wrong, not only emotionally, but financially.

Absolutely. And just to kind of put some numbers to it and, and some companies that have gone through this, it's not just companies that are going on that bankruptcy arc. You know, there are companies that are doing well or have done well that have found themselves in this situation. So just looking back to 2021, 2022, when a lot of growth stocks fell significantly, we saw Netflix falling about 75% in that time. Meta, the old Facebook that fell over 75% in that time as well. So great companies that were doing really well, but also that the stock didn't perform in that time. And so certainly even if things are going swimmingly, um, you're just kind of one market cycle around the corner from, from disaster potentially.

Brian, I think that's a great point. Any executive that owns company stock, and we're talking about high concentration risks like 50, 60, 70, But there's a lot of executives that we work with. Let's imagine these comp— these executives that are job changers. You know, you are with Company A, you got recruited to Company B. A lot of times that come with some stock grants. Sure. So it could be a smaller number to start, 10% or 15%. I think any executive with company stock, they need to have a conversation with their advisor, no matter who that is. Right. Because all of these stocks every year, You know, it's pick your own adventure. Some years they do really well, some years they don't. Think about 2018, 2019 time period when Nvidia fell 65%. Now it turns out that that was more of a blessing than a curse. But if you're an executive at Nvidia and it was 2018, 2019, there's still probably some things you should have done. And now that the shares are riding high, if it's a certain amount of your percentage of your net worth, you still need to have that conversation and have a plan.

I agree. And so kind of just a question that follows on from that, Nolan, is talk about some of the executives that you've worked with where things came out well in this situation, if the stock fell, and then the ones that didn't do well. Like, what was the difference between the strategies of those folks?

So I think a couple of things. One is timeframe. You know, I think the people that are in that preserving wealth stage where you're really close to retirement, where it seems like your timeline is really finite, and it's close, I think they think about things differently than early career executives. I'm thinking about in, one example stood out to me earlier in my career, you know, I was working up on the North Shore of Chicago and we have some big publicly traded companies that were there. Sure. And at the time I was working with a lot of executives, two companies. I'm gonna give you two examples. One was Sears.

Okay.

And then the other one was Allstate.

Okay.

And at the time, Allstate had gone through just many rounds. This was in the early 2000s, many rounds of layoffs. So we had a lot of executives that were working there. And at the time the stock wasn't working. We sat down with a lot of these executives and, you know, again, if they were mid-career and they had time to go, what we discussed at that point was net unrealized appreciation, which is a stock strategy where if you buy company shares inside a retirement plan and those shares go up and you wait to retirement to withdraw, there could be a tax benefit for doing so. So in that case, what we did is adjusted the stock exposure, you know, instead of owning it in RSUs or stock options or an employee stock purchase plan. In this case, it made a lot of sense to just buy those shares while they were low in the 401 account with a certain percentage of their net worth, what made sense for them. And then we felt strongly, we had done some work on the business. We felt strongly that this was a cyclical issue. It wasn't existential. The business wasn't going out. It was just out of favor at the time. So there was no guarantee, but in this case it worked out. We bought the shares low, and then several years later after the shares went up, a lot of those executives were able to retire, pull the stock out, put it into their brokerage account, and it helped fund an exit on an early-out retirement. So in that case, it worked out and worked out very well. There also was a case where we're working with Sears and Roebuck on the North Shore in the early 2000s, and you know, they were going the way of the buggy whip.

Yes.

And in that case, it was, I mean, it was clear in that case, you know, Sears had merged with Kmart. Both of those were dying businesses. And you know, when you dig deep and do company analysis, I mean, we're not always right, but in this case it was pretty clear that that business was being decimated by Walmart, Amazon, online. So the writing was on the wall, right? So in that case, we just told executives, hey, it's best to steer clear of this stock. And if you have shares, it's probably best to liquidate. Let's buy some other stock that we think has a more successful outlook and go from there. So those are two examples that come to mind. Yeah.

So what it really boils down to is you do need to work with someone that has some sort of ability to formulate an opinion on the stock that you're holding, because not all situations are certainly created equal. And we want to be able to speak— what we do with our clients is speak with them and give them our opinion on which bucket we're looking at. Is it you know, kind of the Sears bucket or is it the Allstate bucket? So we're going to discuss that when we do speak with you as an advisory client.

Which is one of the reasons that we do these videos. You know, I feel for a lot of these executives. I mean, these are really important decisions. They're not just emotional. I mean, you have college educations riding on here, kids having, you know, bar mitzvahs, bat mitzvahs, weddings that clients need to pay for. I mean, these are serious pocketbook issues if you get it wrong.

Right.

And unfortunately, a lot of clients are working with advisors who don't know stocks. You know, some advisors just do some wrap program or some mutual fund program, and it's fewer and fewer investment shops these days that actually do rigorous individual stock work where they can actually give you a strong opinion and give you some data and facts to back it up, which is why we're doing these, these videos.

That's right, Nolan. And we just also want to we're talking to people here and today in this video about companies that, you know, you work at a company where the stock's going really well, but we do want you to know there's certainly a risk of it turning around. And that's something that you need to plan for despite your stock doing really well kind of in the present day. So let's move on and talk about one of the issues that keeps people from making changes. Nolan, the most common reason executives give us for not acting on a concentrated position is that tax bill. So we're taping today just a few days after tax day here. And we want to push on that because I think it's something really important that gets lost in the reasoning. You know, if we sell some company shares that are in a gain, yes, it's going to be fairly painful in the near term in terms of my tax bill. But talk about how you think about that concept when it's a matter of diversifying and, you know, there's a cost to it in terms of paying taxes today.

Yeah. Welcome to the house of pain. None of us like writing that check to Uncle Sam, but we must do it. And it trips a lot of people up. Again, my heart goes out to all of these executives and taxpayers who are writing these 5 and 6, in some cases 7-figure checks. Yeah, man, it's a painful thing to do. But the flip side could possibly be worse, particularly when you have a gain. And the most difficult thing, uh, for us and for investors generally is kind of separating those two. Hey, what my tax burden is likely to be versus what the right decision, right, is likely to be. And they're not— they're related, but they're not the same. And a lot of people, as we say, let the tax tail wag the dog, which should be the opposite. You know, we're gonna have to pay taxes regardless, and so there's nothing we can do to get away from that. What we want to do is incorporate it. Even looking at taxes, we want to make the best overall decision. Right. So my decision with the stock really should be independent of what the tax outcome might be.

Right. And definitely something you got to balance the two. And it's not like what we would say to you is say, hey, sell all the stock today. There are more options or more choices you can make than either just doing nothing or doing everything at once. That's something that we certainly work with people over time to manage. But like you say, it doesn't make sense to avoid paying stock and just watch that stock fall, get into free fall, and you lose all your money that way. That's, that doesn't make a lot of sense.

You know, I think the worst case scenario where it gets really difficult, Brian, is when I have a variable tax bill. So let's say me and my wife this year, we have an ordinary tax year and we're in the mid-20s. On an average that we're going to pay taxes.

Right.

Now, if I take your advice, Brian, and I sell my XYZ company stock because I should do it, that's what the analysis says. And I sell that stock, it triggers a big capital gain. And now that takes me from a mid-20s tax bracket this year to a 30s tax bracket this year. That's a little more difficult decision to make. It's going to take me a little bit more time to digest that one.

Yes.

I think it gets a little bit easier when you have these high-earning executives that are in the high third, they're in the top bracket every single year. So it doesn't matter if I exercise and sell this year or if I sell next year, it's going to be the same tax bill. It's just the timing. Those are a lot easier decisions to make. They're not easy. Yeah, but it's certainly not as tricky as couple number 1.

It's interesting that you say that because in terms of making the analysis of the decision, it is easier, but the dollar amount might be bigger. But like you said, we have to break those two decisions apart and keep them independent and make the decision that makes the most sense on a long-term basis. I think what we're saying here is that we don't want to be short-termist in terms of what we're paying in taxes next year and then hurt ourselves for the next 10, 20, 30 or plus years based on that decision.

I think we also need to remember too that there is a difference. This is obvious. Most people are going to know this. But a lot of money has been made by stating the obvious. When we pay capital gains tax, when we sell a stock we've held for 12 months or more, we pay long-term capital gain rate.

Yes.

And for most people listening to this video, at the low end, it's probably going to be 15%. But on the high end, it's going to be 20%. And I may have that net income tax added to me at 3.8%.

Right.

So let's say the high, high end, If I make $2 million a year, it's either 15% versus 23.8%. Yeah, that's going to be the most I pay.

Right.

That's different than my income tax because if I'm in that high bracket where I make a couple million a year, I'm at the 37% ordinary income bracket. So let's distinguish those two.

Yeah, we'll throw it up on the screen. 23.8% is less than 37%. Just to continue with your, theme of stating the obvious. So, and before we close out this part, what do you say to this, to an executive that hears this and says, okay, I get it, but my company stock's doing really well. I expect it to outperform over the next 5 years. Why should I do anything? How do you counter that?

You know, if somebody is just sitting there and they have the position that no matter what you say, I'm not going to do anything, you know, That's not a very rational train of thought. But if somebody's open to change and they're open to reason, let me give you an argument. I don't think we've ever seen one stock go up in a vacuum. Usually it's a group of stocks that are being propelled by some catalyst that drives a group of stocks up. So the argument I would make Mr. or Mr., you know, stock investor guru, let's take your argument and say you can see the future that your stock's going to go up. What I'm going to say is there are going to be other related stocks that are also going to go up and likely an equal or greater amount. So let's trim some of the shares, decrease our risk, and just buy some of the basket, right?

So maintaining your exposure, say, to growth. but in a broader way so that you're not exposed to if something happens bad to your particular company.

Yeah. So let's take NVIDIA. We were just talking NVIDIA quite a bit that had fallen. We can take Meta and its group. And so let's go back to NVIDIA. Let's say I'm an AI bull. I work in AI. I'm an AI researcher. I do chip research. You don't know the business like I do. And sure, you know, I work for NVIDIA. My stock's up 1 million% and it's going to keep going up. Okay, I agree with you. Thank you for telling me. I appreciate it. I'm going to go buy some. But what I'm saying is if NVIDIA goes up, there's a really good chance AMD is going to go up, Avago is going to go up, Taiwan Semi is going to go up. There's a whole group that is related to just that one stock. So now instead of me being exposed just to this one stock and the risk that something happens, right, I can buy a basket And I'm probably going to get an equal movement. It might not be identical, but it's going to be similar.

Definitely makes sense. What we're trying to say is it makes sense to diversify away from that single company risk and maybe take a little bit more of a market risk approach with those same dollars.

I should at least consider it and go through the exercise. I may decide after I've gone through the exercise and done my due diligence, I'm just going to sit tight with this one.

Fair.

That could be it. But you at least need to go through the exercise. And most people have their head in the pillow. They haven't even started to even look out the window. So.

Yeah, exactly.

Okay.

And let's talk a little bit. Let's be practical here. Let's move on to kind of a framework, Nolan. So what we're— who we're talking to mostly here, Nolan, are people who have these, the stock exposure, but haven't really done much about it. They just kind of let it accumulate in the account. Which is great. You're in the building accumulation phase, but now it's time to maybe do something about it. So let's talk about what a framework would look like if you're starting from zero or close to zero. What do you actually do if someone's watching this right now, their stock's up a lot, they know they're really concentrated, they want to make a move and do something to be prudent and diversify. What are some of the steps they can take? Where does that conversation begin?

So one of the easy things, you know, let's hit the easy button here. Let's not, you know, get eccentric. Let's just play it right down the middle here. One of the easy things to do is just dollar cost average out. So I have 1,000 shares. I can trim 1,000— I can trim 100 shares per month, per quarter. We can pick any divisor that we want, but I can start selling shares regularly in small amounts. That way I'm probably not going to hit the top price, but I'm not going to hit the bottom. And then I can start diversifying over a longer period, a year, 2, 3, a month, whatever I would like to do. So that would be the simplest, easiest thing to do.

Okay. Sort of breadcrumbing it out a little bit, selling a little bit here, a little bit there till you kind of get to where you feel comfortable with that allocation. Let's go deeper a little bit. What does it actually look like to answer, what am I, you know, what do I want my financial life to look like? In a way that's useful for building a plan in this regard?

You know, one of the ways to think about it. So speaking of planning, as you know, what we often do with executives is build a lifetime financial model. And so what we're looking at is where we are today. You know, my stock, my income, how much am I saving? How much am I putting in my 401? How much is the company matching? Do I get a pension? Do I get deferred comp? Put all that in the model. I'm paying into Social Security. I know I'm going to get that later if I work for a company that Had a pension. Do I have any annuities? Let's model all that out and we can model it out through retirement. I have an idea of what I'm going to need to spend in retirement. Here's what I'll probably be left with at age 90, 95, or 100. Here's my charitable intent. Here's what I'd like to leave for my legacy. And so we have some sort of idea of that framework. Within that, we're going to use a reasonable assumption on rate of return. Let's pick a number. 8, 9, 10, whatever the number is. So now at least we have a benchmark. Let's say my number is 10. 10 is what I'm modeling for my returns over my lifetime. So now let's compare that to my company and what its future is likely to look like. Is my company a company that historically has grown at 10% plus? And if it has, is it likely to continue to do so?

Exactly.

So at least that's some way, that's some framework to look at it. If I have a company that has grown in excess of 10, let's take Nvidia again. In the case of Nvidia, and let's say it's grown well in excess of 10.

Sure.

And the outlook is gonna continue to grow in excess of 10. So you may look at that and say, well, you know, I got $1 million in stock, it's 60% of my net worth. And if it's gonna grow in excess of 10, Why would I want to do anything different, right? And I'm going to tell you, if your model says you only need 10% returns to go and this is going to expect it to grow much higher than 10%, one, your volatility by definition has to be higher, correct? And you don't need as much of it. That would be the argument, okay? Now, if I have a stock— I have an executive now who works for a slow-growth retail/pharma. I'm not going to mention it because she might be listening. To this recording and the outlook isn't as great. The outlook there is low single digits to middle single digit growth. Yeah. What are we going to do with that stock? Well, you know, if our bogey is 10, I don't think the outlook for this is 10. It's much lower. So it's an easier conversation. Hey, let's move out of this into something with a much more fruitful outlook. So it depends.

Yeah. So it all kind of comes back to you have to have some opinion or analysis of the underlying company that's the stock that you're holding. And if you don't do that, then you're not really doing a rigorous planning around it. And so we want to make sure that, you know, we want to make ourselves available to those of you out there who are looking for a plan and see if we can help you. If you're sitting on a concentrated position, you haven't had a real conversation about it. That's the first thing that needs to change. And that's not next quarter, not next year. Now, this is the time to do it. I'm Brian Dress, Director of Research here at Left Brain. Book 20 minutes with us directly.

No pitch.

We'll just take a look at your situation. There's a link in the description if you want to set some time with us and we'll go through this framework with you and see what— if what you've got in place makes sense or if there's a way to improve it. And also grab our free guide, The Executive's Guide to Equity Compensation. That's also linked below. We've put together an e-book that talks about some of the details around executive compensation in the equity format. We think that there's a lot of value there for you as well as if you want to learn a little bit more about how we see these things. So, Nolan, thank you for being with us. Any other thoughts as we close out today's video?

No, I think this was well done. I think there's a, you know, certainly we can go further. And I think a lot of these executives, you know, we're talking about shares that were granted to them. But, you know, a lot of these executives has also an opportunity to get more exposure. You know, a lot of these companies have employee stock purchase plans, deferred comp plans. And then I also can buy the stock in my 401. So we won't do it on this series, but In the future, we should also talk about not only— we just talked about generically having the company stock, right? But how you own it and in which plan can also be a needle mover.

Thank you for that, Nolan. The final takeaway is don't just sit there with your head in the sand. Do something to do some planning around your equity compensation. Thank you. This has been Fundamentals of Investing. We'll be with you next time.