No one can deny that there is a direct relationship between the amount of risk we are willing to take with our investments and the returns we can expect to receive. Stocks, bonds, and real estate are all investments that have the ability to provide a nice source of income, but in order to see that reward, we must expose our principal to a certain amount of market risk.
The inherent risk lies in the fact that each of these investments is susceptible to market fluctuations for better or for worse. And as we know, the market is not static. External forces such as a change in domestic policy or strained international relations can cause unpredictable fluxes in market movement at a moment’s notice. Even worse, macro events such as another great recession or depression can cause havoc on markets. You may have too heavy an allocation of funds in a particular security that happens to suffer large losses. And conversely, if you have a portfolio too heavily weighted in bonds, you run the risk of not having the needed returns to fund your financial plan in order to realize a positive real return over and above keeping pace with inflation.
The question, then, is how to manage risk in such a way that we are able to take advantage of the market’s efficiency while protecting our assets from bearing significant loss in less favorable economic climates. The answer is making decisions based upon the proper balance, diversification, and risk tolerance level for each client’s unique situation.
Sales professionals, however, who are often compensated with company holdings or who participate in Employee Stock Purchase Plans (ESPP), may be overexposing themselves to a level of elevated risk that could severely threaten their long-term security.
Individual Security Risk
Individual security risk is something that all investors can fall prey to if they aren’t careful. However, since many sales executives are either compensated with shares in their company or are strongly encouraged to purchase equity in the company through an ESPP, they are often far more susceptible to highly concentrated stock positions. Sales professionals take advantage of the company’s stock options or receive bonuses in the form of company shares while busy schedules and pressing work matters divert their attention away from monitoring their portfolios. Before they know it, they are overweighted in a single security and inviting unnecessary risk into their financial plan.
When an individual has 5% or more of their portfolio invested in a single security (i.e. stocks, restricted stock options, or bonds), they are said to be holding a concentrated position. Holding a concentrated position subjects investors to a type of dangerous investment risk that, if not mitigated, should be reflected in the assumptions when creating and implementing a financial plan. While the returns for a well-diversified portfolio will move up and down with the economy and the market in general, an overconcentrated investment in a single security could lose most, if not all, of its value without warning due to unpredictable factors unique to that specific company.
Since sales executives are put in a position with their compensation options where they are naturally inclined to this potentially damaging level of investment risk, diversification, hedging, and more frequent re-balancing could be of the utmost importance.
Furthermore, if your concentrated position is in the company you currently work for, your risk increases even more significantly. If the company that employs you runs into trouble, or suddenly dissolves, you could lose your source of income as well as the equity previously held in those investments. Veritably, in this situation, you stand to lose your job and a substantial portion of your assets due to forces completely outside of your control.
Oftentimes, as successful business people, we tend to falsely believe that working harder or working longer will grant us complete control over how successful we’ll be or how much money we’ll bring home. This is true to an extent, but when it comes to investing, the amount of real control we have centers around how much risk we are willing to take. Essentially, we have to ask ourselves, how much control of our future are we willing to hand over to risk?
At Meenes Wealth Partners, we recognize the many benefits that incentive compensation structures afford, but also remain aware that these benefits pose unique risks and complexities to the financial planning process that must be addressed. If you are a sales professional who is currently compensated, or has been previously compensated with company holdings in the past, you benefit from an evaluation of your current exposure to risk. Contact us today to schedule your complimentary Get Acquainted meeting.