How Much Employer Stock is Too Much?

A reader writes in, asking:

“How much employer stock does it typically make sense to hold in one’s portfolio?”

From a financial planning standpoint, the ideal amount of employer stock to own is “as little as possible.” If anything, an argument can be made for having a negative allocation to employer stock (e.g., by using various options strategies that benefit if the stock goes down).

It’s true that many people have become mega-millionaires through ownership of employer stock (see: Microsoft). But many people have also experienced financial ruin through ownership of employer stock (see: Enron).

Owning individual stocks (as opposed to diversified mutual funds) is generally undesirable because it results in “diversifiable risk,” which is risk that is not, on average, compensated with additional return. (See this article for more on that topic.)

Owning the stock of your employer is, on average, even worse, because it causes your employment and your portfolio to be exposed to the same set of risks. Getting laid off is a bad financial scenario. Getting laid off at the exact same time that your portfolio tanks can be a catastrophic financial scenario — definitely the sort of thing that it makes sense to go out of your way to avoid, if possible.

That said, there are some cases in which it is more or less unavoidable to have a portion of your portfolio allocated to the stock of your employer. For instance, some employees are compensated with “restricted stock” that they cannot sell until certain conditions have been met (e.g., the employee has held the stock for a certain number of years). Alternatively, some employees are allowed to use a portion of their income to purchase employer stock at a significant discount, but they aren’t allowed to sell it within a certain number of months.

If employer stock is a part of your compensation, there’s no sense in turning down free money. But as soon as you can sell such stock, it generally makes sense to do so.