Ygthkb

I'm just finishing up paying off my student loans (woohoo!) and am starting to look at places I can put my money to make it work for me. I've read Kobliner's Get a Financial Life and am interested in starting with ETF's, but I have a slight dilemma.

I work for a medium-sized company that is publicly traded on the NYSE¹. They offer a program where I can allocate up to 15% of my paycheck (after tax) to buy their stock at 85% of the price. The only stipulation being that I have to hold it for 180 days (~6 months).

To me this seems like free money. The second that stock is bought, I've already made 15/85 = 17.6% on my money!

I'm very tempted to allocate the full 15% of my paychecks to this, but I know that it's important to diversify my investments.

I was planning to use 20% of each paycheck to play with for investments--would 15% company stock/5% ETF be diversified enough? Should I drop to 10%/10% or lower? Is there some reason I'm missing to not go all in on this?

^{1. It's worth noting that this company's stock has done incredibly well in the last 10 years. While I'm not expecting it to keep the same growth it has, this company is definitely not going anywhere anytime soon. An investment with them would definitely be safe. I have the utmost confidence in this company.}

It's no necessarily free money. If the stock declines by >15% in the six months after you buy it then you've lost money on the deal.

However assuming your company is performing at least reasonably compared to other stocks, you are, on average, getting a 15% bonus to your savings. You shouldn't be turning your nose up at that. (if whatever other stocks you invested in declined 15% after you invested you'd lose 15% instead of just breaking even).

There is a bit of a diversification factor in that not only would you be keeping your savings in one company, but its a company you work for. If it goes under, not only are you short some savings but you are also out of a job.

However the diversification problem is short term. You only have to keep the shares for 6 months, and you can sell them after that.

Let's say you are earning $50,000 and can afford to put $10,000 (20%) into savings. The first six months you put $7500 into your company, $2500 elsewhere. You are pretty vulnerable for that six months, but it's only six months.

In the second six months you again put $7500 into your company, but you also sell the original $7500. Now you have $7500 in your company but $12500 elsewhere. That makes you much less vulnerable. After a few years you are pretty diversified, and you've taken full advantage of the 15% bonus.

This is probably above your pay grade but if your company's stock offers options, there are a number of hedging strategies that would protect you.

The simplest one would be to buy 6 month puts whose break even was less than 15% out-of-the-money. You'd be throwing away that premium but it would protect you against all loss of principal.

As a random example, consider a similar 15% opportunity today with IBM at $136.00. 15% lower is $115.60 and below that you'd lose money. Buying the Oct 120 put (7 months) for $3.75 gives you a break even price of $116.25, below which you are 100% protected. The worst case scenario is that you make 65 cents and the best case scenario is that the investment appreciates above $136.00, providing an additional profit beyond the 15% ($20.40) minus $3.75.

If IBM were to drop to near or below $120 before October, the put would also gain time value and the net position would be worth more than the break even values. I'll leave it at that since this is another rung up the option food chain.

If I had this 15% discount opportunity with savings on the side and I wanted to hedge, my preference would be a modest debit OTM long stock collar - potential to make 10% more to the upside (above and beyond the 15%) and the potential to lose only 10% of the 15% to the downside (yes, another rung up).

If your stock does not offer options and I've you believe that it's a fundamentally sound company, I'd still load up on it, to the maximum of 15% if you can manage it. The 15% is absolutely free money. You may lose it due to market conditions but that 15% is not your money being lost.

Investors in the market lost 20-25% last December. I think that every one of them would be thrilled to have been shielded from the first 15% of loss. You're young and losing 15% of your salary in 6 months is painful but not the end of the world.

When I first started investing 40+ years ago, I opened a number of DRIPs with companies that offered a 5% discount on dividends as well as a 5% discount on new money. It definitely helped with the early stage of my accumulation phase.

And FWIW, I employ some synthetic option strategies that offer a downside buffer of 15-20% with an upside cap of maybe 10%. Most of the time, this is captures a large part of the up moves and avoids most of the downdrafts.

Should you decide to follow this advice and you lose it all, I'll be changing my handle ;->)

I will add some things to DJClayworth's excellent answer:

1) There will be transaction costs. To sell the stock there will be some cost, and perhaps event to transfer money to the account that you use. Also you will have to pay short term capital gains that will be taxed at your top marginal rate.

2) There will be "tax" on convenience. You will have to remember to login, and trade your stocks after the holding period. You will then have to transfer the money into an account you use. Then what do you do with it? Also you will have to file a Schedule D with your taxes.

3) There could be opportunity costs. While many advocate short term trading, there is a lot of research that says buy and hold wins over the long haul.

For example you could have bought into the mutual fund FOCPX, which over the last three years averaged 22.44% each year. Not only would you have made more money, but you would not have to pay capital gains tax on all of it if invested in an after tax account. Had this been in a tax favored account, the money that was paid to the IRS could have been compounded into even more gains. Another example of this is PRGTX which fared even better 24.75%/year for the last three years. Either one of those investments would have greatly reduced your risk and returned more.

4) The biggest down side is if you continue to hold company stock; or, if you just spend your profits. In the first you will be taking on a catastrophic risk (your investments and livelihood are all wrapped up in one) for only mediocre returns.

If you just spend your money then you are missing out on the power of compounding. You are far better off having an 8% rate of returned that compounds rather than a 15% return twice a year if you are a long term investor. Around year 4, the 8% compounded fares better and continues to increase the margin.