Here is the Harsh Truth About ESOPs and Why You Should Be Careful

Tech company shares in the US markets took a hit, reminding us that one should not have abundant ESOP plans in their portfolio.

Harsh Truth About ESOPs

Many people have retired early due to their stock option plans. Several startups offer stock option plans to their recruits for this reason. Senior employees are also willing to take stock option plans as a part of their compensation. However, these stories are rare and good to hear only when stock prices increase. 

ESOPs Have An Inherent Dark Side 

Nokia and Kodak were two massively successful companies in their time. However, imagine what their employees' problems with stock option plans must have gone through when their stocks became worthless. Tech company shares in the US markets are taking a hit, and the dark side of ESOPs is slowly becoming more evident to their employees with stock option plans.

The FAANG stocks (Facebook, Apple, Amazon, Netflix, Google) had a massive price correction. It outlines the dark side of ESOPs. There is a huge question mark on whether the correction will lead to a peak return in the time to come, especially in a non-zero interest rate environment. 

Read Now: All you need to know about ESOPs

Let's look at an example of how the dark side of ESOPs is affecting people in real time. 

A person working at a well-established company like Adobe in the tech space has 80% of his net worth connected to Adobe's shares. However, the stock prices fell from their high of $700 each to a mere $290 in only one year. It equates to a 60% correction. Their profit was around Rs. 1.3 crores at one point, which fell to Rs. 55-60 lacs. While this person is positive and hopeful about the future of his company, he believes he should have cut down his exposure. 

This person has an Rs. 1 crore outstanding home loan, which he could have cleared with the ESOPs only a few months ago. It shows how one should have abundant ESOP plans in their investment portfolio. 

Being Prudent

While companies will continue to offer their employees equity incentives, we never know when things can go south. Undoubtedly, these options can create huge wealth. However, history has shown us that well-established companies can go down and take their employees with them. Youngsters go after ESOP-offering startups blindly and fail to understand that their startups might not exist in times to come. 

Read Now: Are ESOPs enough to retain employees?

How to Handle ESOPs in Your Investment Portfolio

Here are the best ways to handle ESOPs in your investment portfolio: 

  • Never ignore the employer stocks that you hold during your analysis. 
  • Treat these as a part of your equity exposure which should be in line with other equity funds and direct stocks. 
  • ESOPs increase concentration risk in your investment portfolio as they are single stocks. 
  • Only allocate employer stocks to the point where you do not decimate your finances if the price goes to zero. 
  • While the exposure percentage cannot be precisely decided, 20% is a good exposure percentage.
  • Review your finances yearly and partially liquidate if required.

It might seem not very smart to sell your stocks when they increase. However, keeping your investment goals in mind would be best. You are not in a race to become a billionaire and must act prudently by limiting your risks. Your income depends on your employer, and you do not want to depend on others for it, do you?

ESOP - Employee Stock Option Plan EXPLAINED in Hindi

Disclaimer: This article is intended for general information purposes only and should not be construed as investment or legal advice. You should separately obtain independent advice when making decisions in these areas.


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