You have been working in a dead-end government job where you are underpaid, over-worked, and under-appreciated for the past 3 years. You then get word of a job opportunity available at a hot new start-up company in Colorado. It is basically the future of the industry in which it operates. The company currently only has 20 employees, and therefore, you have the possibility to get in at the ground level of this huge happening!
You land the job, move to Colorado, and get started in your new position. After two weeks or so, it comes time to get all of your benefits, insurance, and finances in order. This includes deciding how you want to invest your 401k funds. In the 401k exist the normal options of actively managed and index mutual funds. However, since this is a hot new start-up, you also have the opportunity to buy stock in the new company at an 8% discount of the market price.
The question then becomes, “What do you do?”
Even though it is very tempting to buy stock in the hot new company with a very promising future, you absolutely should never buy stock in the company from which your salary comes for your 401k account. Say that again with me, NEVER! This even applies to company stock in larger companies on the S&P500 as well! It is never a good idea.
Why is this exactly? Basically, it all comes back to the issue of diversification and not putting all of your eggs in one basket. The whole reason I prefer purchasing index mutual funds is due to the fact that it gives you broad exposure to hundreds, if not thousands, of companies. Since there are large number of companies, if one company goes bankrupt, you will not lose large amounts of money.
Additionally, let’s take a look at an example. Let’s say that this employee at the hot new company in Colorado currently has the average US net worth of $93,100, and makes an annual salary of $50,000 at the new company. By doing the division, the first year you work for the new company, already 53.7% of your total net worth is going to be dependent on the company. This is ALREADY a very high percentage! You absolutely do not want any more dependence on this one source than you already have.
Therefore, you should try as much as possible to invest in other investment vehicles through your 401k account!
When Would You Purchase Company Stock?
So, you’re probably wondering right now if there ever exists a time when buying company stock is an acceptable behavior.
For me, the only time that I would ever buy stock in the company for which I work is in the following scenarios:
- If I used part of my alloted “play money” to buy the company stock. See post on play money for more information on this topic – My Money Blog – Play Money
- If your supervisor gave your stock options as part of a yearly bonus, and you cannot renegotiate for a cash bonus/raise instead.
- In this case, I would exercise the stock options as soon as they reached the eligible exercise price and cash out my earnings. I would not remain in company stock.
- If I was already wealthy enough to have secured a comfortable retirement for myself.
- It is perfectly fine (and actually preferred) for you to buy stock in the company for which you work if you are rich (for example – if you were a Board of Directors member) and already have made enough money to know you will live comfortably in retirement. The key takeaway with company stock is that you do not want your RETIREMENT dependent upon one company. In fact, directors of companies should own stock in the company for which they work in order to show that they have a vested interest in seeing the company do well!
As always, please let me know if you have any questions.
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