Adjusting your stock compensation strategy during a recession
If you’ve been reading market news lately, or listening to economic or financial podcasts (yes, these are my running podcasts of choice!), it’s likely that you’ve heard that we’re going into a recession. These words sound scary, and recessions can certainly be scary depending on your situation at the time. We won’t ever be able to accurately predict if we are going into a recession, similar to how we can’t time the market. We also can’t give blanket advice on what to do with your company stock, and always recommend seeking individual financial advice from a qualified and licensed financial planner (CFP® or CFA®). However, if you’re working for a company and receiving a portion of your compensation as restricted stock units (RSUs), stock options (ISOs or NSOs), or employee stock purchase plans (ESPPs), it’s likely you've already experienced a downturn in your annual income based on your company’s stock price going down. In this blog, we’d like to shed some light on how to think about your stock compensation in this depressed stock market environment, especially if we do head into a recession.
This year has been tough for stock market investors. The S&P 500, representing the 500 largest companies in the US and typically referred to as the US stock market (and we’ll refer to it as “the stock market”), lost over 20% of its value this year. It’s not uncommon for the stock market to lose money each year; in fact, on average the stock market drops 14% intra-year. However, losses of greater than 20% are much more rare. Since 1990, this has occurred only 9 times. The stock market performance is considered a leading indicator of the economy. Forbes provides some details regarding historical markets: “No two bear markets are exactly alike,” writes Bespoke Investment Group, pointing out that 8 out of 14 prior bear markets since World War II have preceded recessions, while the other 6 did not.
Investor behavior can really drive stock returns. The stock market is one of the few things in life that people don’t like to buy on sale. If we look at the stock market today, down 20%, it’s a much more attractive entry point than where it was at the start of the year. However, at this time, many investors are worried about the impact of a recession. It’s a worthwhile concern depending on your time horizon. Again from Forbes and Bespoke, in a bear market followed by a recession, stocks fall by 35% on average and are down for longer, an average of 449 days, whereas without a recession, stocks fall 28% and recover in 198 days.
What’s comforting about investing in the market is that you can take advantage of averages. Individual stocks may outperform investing in diversified index funds, but the opposite can also be true. For example, in 2021 the S&P 500 total return was almost 29%, but Activision, Citrix, and Fidelity all lost over 20%. This is a financial concept known as dispersion, or simply put, how far from the average a stock performance strays. As of the date of this blog, the stock market is down 18%. The best performing stock is up 95% and worst performing is down 70%.
To summarize our market overview, we’ve covered:
We entered a bear market this year, or down 20% in stock market performance.
A recession is possible, and the stock market recovery from a bear market typically takes longer in a recession.
Individual stock performance can vary significantly from index performance.
So now let’s talk about what you can do about it, depending on your stock compensation and financial situation.
Financial Stability Basics
Unemployment rises in recessionary environments, and we’ve already started to see companies layoff employees. Crunchbase reported the number of layoffs experienced in companies so far this year, notably Coinbase has laid off 18% of its workforce, Peloton 20%, and Compass 10%. Taking the steps to ensure that you are financially sound in the case of a layoff is essential. We recommend maintaining an emergency fund of 3-6 months of expenses, depending on who relies upon you. If you have anyone other than yourself relying on your income, 6 or more months is advisable. Your emergency fund should provide you with enough money to support you and your family during a time of transitioning jobs.
You might also consider how to dial in expenses, to ensure you’re living within your means, and saving on a monthly basis. Bolstering your cash, or diversified investments if you’re fully funded in your emergency fund, is a great way to take advantage of a stock market on sale, and to provide yourself and/or your family with additional padding if an extended recession were to occur.
We also recommend having open conversations with your partner or spouse if you have any concerns regarding an upcoming recession, and what it would mean for your financial situation. Open dialogue builds trust, and we know that when partners work together on their finances, they are much more successful.
Let these considerations serve as your foundation before you think about our next topic: stock compensation.
RSUs in a Public Company
If you’re earning RSUs in a public company stock, it’s like you are receiving a cash bonus and deciding to invest it into your company’s stock. Let’s assume you are vesting each quarter, and you’re working for Netflix (this year’s worst performer, down 70%). It likely feels painful to sell your stock at -70% from its highest value; completely understandable! It’s natural to hang onto the times where a stock was trading at all time highs, but what happens next depends on your financial situation.
Let’s assume you’re in the highest tax bracket (37%). The stock vests at $190/share, Netflix’s current stock price. With RSUs, companies are required to withhold 22% for Federal taxes, and they typically do this by selling shares on your behalf. So if you vest 100 shares of Netflix this quarter, they will sell 22 shares and send the money to the IRS on your behalf. The problem is, you owe the equivalent of 37 shares. Therefore, our first tip is to make sure you sell enough to cover your tax bill. Of course, the stock could go up, but just because the stock is down 70%, doesn’t mean it can’t drop even more. The one thing you do know is that you’re vesting 100 shares at $190, you’ve paid $4,180 in federal taxes (22 x $190), and you still owe $2,850. By selling 15 shares on the day of vesting, you lock in the price that you owe in tax.
Your company will also be withholding for state taxes (California at 10.23%), and FICA / Medicare taxes (7.65%) if you haven’t met the $150k threshold for the year, so this means you’ll likely have 45 shares remaining on this vest. Consider this your after-tax bonus that you invest in your company’s stock. So should you sell at these prices?
Our advice here is to remove the price from your mindset. The questions we think about when approaching a stock compensation strategy include:
Do you need the proceeds from your RSUs to cover near-term expenses? If so, what is the minimum amount you need to cover these expenses? You might decide to sell, because you’re getting close to that threshold, or use this information to set a minimum price target, or the price that you should absolutely sell.
What price would you be happy with? Be reasonable here. Stocks don’t double overnight! Set an alert on google finance or yahoo finance, or with your financial advisor.
How much stock do you currently have in the company? If you have over 10% of your net worth in your company’s stock, it’s worth evaluating the risk you’re taking. Concentrated bets, regardless of what they are, can ruin a financial situation.
Do you have other types of investments? We are big believers in diversification. If your company’s stock is your only investment, it would behoove you to invest in something else!
The last tip is negotiating your compensation! We know companies are laying off employees, and could cut wages, but we have seen individuals continue to increase their compensation even amidst recessions. Perhaps your company is doing well in this environment, or you’re getting promoted, or you’re taking over responsibilities of individuals at your company who were let go. These are all reasons to advocate for your compensation.
Even if you can’t get an increase in your compensation package due to hiring freeze / wage increase freezes, RSUs in a down market can actually be hugely beneficial. Typically companies will offer RSUs based on a dollar amount, versus a fixed share amount. Let’s go back to the Netflix example, and assume that typically you earn $95k in stock refreshes each year that vest over 4 years. If the stock price were at $300/share, you would only receive 316 shares on a 4 year vesting schedule. However, at the current price of $190/share, you would receive 500 shares. If there is a recovery in share price to previous levels, your upside could be significant.
Stock Options
Moving onto stock compensation’s most complicated topic: stock options. There are opportunities to be had when stock prices are down, but these opportunities are risk additive, so it’s important to revisit the questions we addressed for RSUs (slightly evolved):
How much stock do you currently have in the company? If you have over 10% of your net worth in your company’s stock, or if exercising more shares would bring you to over 10%, it’s worth evaluating the risk you’re taking. Concentrated bets, regardless of what they are, can ruin a financial situation.
Do you have other types of investments? We are big believers in diversification. If your company’s stock is your only investment, it would behoove you to invest in something else!
When you exercise stock options, you have to pay tax on the bargain element, or the difference between the current market value and the exercise price of your shares. For non-qualified stock options, you pay ordinary income tax, and for incentive stock options, you pay alternative minimum tax. These taxes are at your highest tax rate. If your stock price is down, and you exercise shares, then you pay less tax at the time of exercise.
It’s not to say that your stock price won’t go down further, so you might decide to divide your exercise up into smaller investments over the next 6 months. If you are able to lock in lower fair market values, and your stock price recovers in the next 1-2 years, you could sell and pay long-term capital gains taxes, versus ordinary income. For the top tax bracket, this is the difference of 37% versus 23.8%.
Lastly, negotiating your compensation for additional stock options can have huge effects at times where your stock price is lower. In stock options, there is greater leverage to the upside, both in terms of increasing the number of stock options that you can be granted, as well as lowering the exercise price for your grant.
If you’re working in a private company
Private markets tend to be less volatile than public markets, not because they are any different fundamentally, but because there is a lack of pricing transparency and market participation. In the stock market, individuals are buying and selling all day every day, which causes prices to fluctuate. Private markets do tend to behave similarly to public markets on an overall basis – for example, we’ve seen valuation multiples drop, and companies with higher cash flow or profitability receive better valuations in this market environment - but the fair market value of your company’s stock may not change for tax purposes unless you receive a new 409a valuation, or a tender offer.
If, however, you do receive an updated 409a valuation, you might consider exercising more shares, as your overall tax bill would be lower. This allows greater opportunity for an eventual IPO or tender offer that your gains would be taxed at the preferred long-term capital gains rates.
If you’re receiving RSUs in a private company, similarly, you might receive the same benefit of additional shares in a stock grant as someone in a public company, since companies typically target a fixed dollar amount to grant their employees, versus a fixed share amount.
Summing it up
Recessionary times can be challenging, and ensuring that you have strong financial stability is essential to any financial strategy. While we provided some insight into how you can think about your stock compensation during a bear market, and a recession, we also advise that anyone who has stock compensation works with a financial planner with a CFP® or CFA® designation. Stock compensation is complicated and can have significant investment risk and tax implications. We hope you gained an understanding that despite a market downturn, opportunities do exist to re-evaluate your personal finances, and consider opportunities for your long-term future.
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Stephanie Bucko and Cristina Livadary are fee-only financial planners based in Los Angeles, California. Stephanie is the Chief Investment Officer and Cristina is the Chief Executive Officer at Mana Financial Life Design (FLD). Mana FLD provides comprehensive financial planning and investment management services to help clients grow and protect their wealth throughout life’s journey. Mana FLD specializes in advising ambitious professionals who seek financial knowledge and want to implement creative budgeting, savings, proactive planning and powerful investment strategies. As fee-only fiduciaries and independent financial advisors, Stephanie and Cristina never receive commission of any kind. Stephanie and Cristina are legally bound by their certifications to provide unbiased and trustworthy financial advice.