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Every Six Months

At the end of January and August of each year, my attention is brought back to the company Employee Stock Purchase Plan.  I’ve gotten my email reminders that the window is open to make any adjustments for the next period.

It also makes me excited because the last period vests on the 31st and shares are purchased on my behalf with the amount that I’ve contributed.  Cool!

What is ESPP?

Here’s the definition from Investopedia for anyone who isn’t familiar with an ESPP:

DEFINITION of ‘Employee Stock Purchase Plan – ESPP’

A company-run program in which participating employees can purchase company shares at a discounted price. Employees contribute to the plan through payroll deductions, which build up between the offering date and the purchase date. At the purchase date, the company uses the accumulated funds to purchase shares in the company on behalf of the participating employees. The amount of the discount depends on the specific plan but can be as much as 15% lower than the market price.
Read more: Employee Stock Purchase Plan (ESPP) Definition

Why I Like It

My company’s plan does use a 15% discount on the purchase price of the stock.  It also selects the purchase price from either the first day of the period or the last day of the period, whichever is lower.

That means that I can sell the shares on the day they are available in my account and make around 15% profit for a six month investment at minimum!  Those returns are really great.  Yes, I will pay short term capital gains on the profit (difference between purchase price and sale price) but I’m still getting better returns than most investment options.  Remember, this is for a six month period.  That makes for a 32.25% annualized return.

Now, if the purchase price from the beginning of the period is used and the current price is higher, returns will also be higher.

Example

Let’s say, for the sake of example, that my company’s stock price at the beginning of the last period was $75 and is currently around $40 (It’s been a tough market for a lot of stocks the past nine months).

So, my purchase price this go around will be $40 minus the 15% discount which gives me $34.  Let’s also assume that I’ve contributed $3400 this period.  I will be purchasing 100 shares at $34.  The next day when me shares are available, the stock is still sitting at $40 and I sell immediately making $600 profit (minus brokerage fees)!

If the situation had been reversed and the period had started at $40 and ended at $75, I would still be buying 100 shares with my $3400 since we select the lowest of the two prices and discount it.  Now, however, I’m selling at $75 for a $4100 profit!!

Potential Downside

Now, one of the drawbacks can occur if you decide to hold your shares.  Let’s say $75 was the purchased price after discount and you held.  Now the stock moves down to $40.  It may or may not ever recover and you have taken a loss on the position.

My personal belief is to sell the shares immediately if the value of the purchased shares is greater than 1% of my overall investment portfolio.  I want to be diversified and not holding a large percentage of company stock.

If the holdings are less than 1% of my portfolio, maybe I would hold for a bit if I believe strongly in the direction of the company.  Who knows, I haven’t gotten there yet.  Besides, I have debt to eliminate!

How I’m Using My ESPP

In the past, I’ve used the gains from the ESPP investment to go toward debt reduction.  Then I take the amount of the original investment and roll it back into my long term investment account to reallocate.

Since I am trying to pay down debt and I haven’t been accruing any interest on credit cards, I’m actually contributing more to my ESPP than I am to my 401k.  I know most finance gurus may argue against this, but it’s a short term approach and I will be increasing my 401k and IRA contribution once the consumer debt and smaller loans are gone.

This time around, I may actually take the amount that I contributed and also apply it to debt reduction.  This would effectively reduce the amount that I contributed to investments in 2015 since I would basically be making a withdrawal to do so, but it might be worth it to see those debt balances disappear.

Conclusion

It took me several years to figure out the best approach for leveraging ESPP.  At my last company, I just held it all until we need to make a downpayment on the house (some of the shares were underwater as I described above).

Now, with the sell immediately plan, I feel that I can take full advantage of this powerful tool.  In fact, I just increased my contribution to 8% which should maximize the amount that I can contribute this year.

Like a good friend once said, ‘never turn down free money’

Cheers!

-cb3