Buying and Selling Your Employer’s Stock

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A growing number of companies are scrambling to come up with enough shares for their employee stock-purchase plans, suggesting that employees are eager to get the most they can from this benefit, despite the risks.

Are those risks really worth taking?

They can be, if they are kept under control. That takes some diligence.

The typical stock-purchase plan allows employees to buy their firm’s stock at a discount, usually from 5% to 15% off the market price on the day the purchase is made. Employees designate a sum to be deducted from pay to make the purchases. The maximum is usually 10% of gross pay.

Because a given sum buys more shares when prices are down, many companies are running short of shares earmarked for these plans, according to The Wall Street Journal. Managers can ask shareholders for permission to allocate more shares to their plans, but they are sometimes reluctant to because that dilutes the value of the holdings.

Many employees simply designate a portion of pay for stock purchases and allow the shares to build up over the years as a kind of supplementary retirement fund. But that can be a mistake if it ties a substantial amount of money to a single stock that could lose value. Financial advisers generally say that individual investors should not have more than 10% of their holdings in any single stock.

For many employees, the best strategy is to reap the benefits of the employee discount, then sell shares from time to time to keep the holding from getting too large. The proceeds can be used to buy other investments.

One option is to sell the shares soon after acquiring them. If the purchase is made at a 15% discount and shares are immediately sold for full value, the employee would enjoy a quick 17.6% gain. That’s because a $100 share would be bought for $85 and sold for $100, a $15 gain on an $85 investment.

An alternative is to hold the shares for longer than 12 months to minimize tax.

The tax rules are complicated and depend on how your plan is set up, so it’s best to check this out with the company.

Generally, the discount in the purchase price will be treated as income, while profits from share-price gains will be treated as short- or long-term capital gains.

While holding the shares for longer than 12 months can trim the tax bill, it also exposes you to the risk of loss if the share price falls. Of course, the shares also could rise in value. Whether to hold on to them or sell quickly depends on your assessment of the company’s prospects. The trick is to do this as dispassionately as you would for any other firm’s stock.

If you are not a sophisticated investor accustomed to analyzing individual stocks, be especially careful about accumulating too many of your company’s shares. Many employees who have invested deeply in their own firms have been badly burned but, of course, some have grown rich. It’s hard for an amateur to predict whether their company will turn out to be a big winner like Google (Stock Quote: GOOG), or a disaster like Lehman Brothers (Stock Quote: LEHMQ.PK).

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