More people have some part of the compensation tied to company stock these days.  Some are stock options.  Some have company stock match in the retirement accounts.  Some have shares purchased from employee stock purchase plan (ESPP) at a discount.  Some have shares granted through restricted stock unit (RSU).  The question arises naturally on how to deal with the company stocks in various forms, especially when you have multiple forms of the company stocks.  The decisions would be very easy if you know beforehand that the company stock will go to zero like Enron’s, or will out-perform the general market like Google’s.  Unfortunately, no one has this knowledge.  Considering both tax consequences and asset allocation, here is my two cents worth:

1. One should not keep too much networth in the company stock shares for the purpose of diversification.  How much is too much can be hard to determine.  My conservative suggestion is maybe less than 12%.  Anything more than 35% is definitely too much.  Obviously you work for a company that you think or hope to be promising.  But having too many eggs in one basket is never good.  Company stock shares are defined as any shares owned in the form of RSU, ESPP, or 401k account matching.
2. Stock options of your company are a different game.  At appearance, their purpose and function are like shares, except that stock options have more leverages.  Financial leverage can give you big gain or big loss.  However, in the worst case, you gain nothing from your options.  The half-empty view on options is that once the stock price goes below your strike price, your options will become worthless.  The half-full view on options however is that without putting any money down, except your agreement to continue working at your company, your options will financially control a much bigger stake of assets.  That is the same as having some equivalent amount of money invested in the stock market, without putting any money down.  Therefore, I think only under two circumstances should one sell the stock options:
1. You think the stock price is too high or quite high, and may not reach this price for a long time in years, or at least this is the high point before you make your exit from the company.
2. The percentage of your networth in company stock options is getting too high to be comfortable for you.  Because of the leveraging power of options, I will not use 12% rule from the company shares.  I think even 50% is advisable, but probably not beyond that.  Remember that the value of your options is different from the controlling stake of your options.  The true value of your options when you exercise the options is after deducting the strike price, and after some 40% tax bite.  But the controlling stake of your options is simply the number of shares of options multiplied by the current market price.  For obvious reason, if you hold onto stock options, then you should definitely cut back on your company stock shares.
3. When you have various forms of stock equity interest in your company, such as options or ESPP, you should diversify out of your company by selling the LOWEST cost basis first.  The lowest cost basis shares are in the following order: 401k company matching shares (because there are no taxes in retirement accounts), RSU (zero cost basis in an after-tax account), ESPP (shares that you bought with your own money), and then stock options.  Selling shares in such order will enable you to sell the least amount of shares to get the most of the after-tax money which you can then allocate to other types of investment to adjust your overall portfolio risk.  The only exception in which I will sell options first is when I firmly believe that the stock price will never go this high again (before I leave the company), and in the near future, the options may go under-water.

I often see people doing the exact opposite to #3 above, fearing that their options will go worthless after the experience of the 2002 great bear market. But they forget that one of the hidden values in the company stock options is that their option expiration dates can be 4 to 10 years long from the grant date.  If you were to buy such long term call option (also called LEAP) at the open market, you either can’t find such options with long expiration, or that they are outrageously expensive (possibly priced by the Black-Scholes option valuation model ).  Exercising the stock options early is essentially giving up all the time value inherent in the stock options.  I’m not saying that you should exercise the stock option on the last day before it expires.  But simply having a longer term view on the stock options will probably bring you more gain, especially under an inflationary environment.

Have you wondered how some people get so incredibly rich?  There is a saying: “you need money to make more money.”  If you hear that from a poor person, it may sound a little sour-graped.  But underlying it, there is probably some grain of salt, not well-understood by the person who says it, but a good observation nevertheless.

What happens usually is that you need money or asset to borrow a lot more money, using which you can make even more money out of it.  It is a game of leverage.  The money-making potential is always proportional to the total amount of money involved.  Whether it’s borrowed or not, it doesn’t matter.  So when a business owner is successful in his or her venture, he or she will be handsomely rewarded.  But if he or she fails, the leverage works in the reverse gear and may lead to substantial loss or even bankruptcy, depending on the company structure and amount of risk and leverage that is undertaken.

In fact, leverage comes in many forms, and in each case, you can see its multiplicative power.

1. Leverage of employee’s time: As long as each employee can bring in more money than his or her wage, then the money left or the net profit goes into the employer’s pocket.  The employer or the business owner is leveraging on employee’s time to make money.  Multiplying by more employees is multiplying the profits.
2. Leverage of the machinery: As an example, for an internet retail business, it leverages on computer equipments to take purchase orders.  Equipments have a fixed cost.  As long as the equipment brings in more money before its utility is fully depreciated, then it’s good business.  Multiplying by more equipments for machinery is multiplying the profits.
3. Leverage of copies or copyright or franchise: This is leverage in the purest form of multiplication.  More copies of songs or CDs, more copies of software, more copies of books or DVDs, will all result in more profits for the owner of copyright or franchise.

These are the reasons that in Robert Kiyosaki’s four quadrant of E/S/B/I, B (business owner) is a better money-making model than S (self-employed) because of the multiplicative power, while S relies solely on the available time of oneself, to be multiplied by a very high per hour rate to reach a good income level.  However, using leverage is not risk-free at all even when you control your own business.

The other forms of leverage are financial leverages:

1. Margin: Margin power in stock is usually 2X of your cash.  Margin in forex trading can go upto 400X.
2. Asset-back loan: mortgage debt.
3. Other loans that are not back by assets: Credit card debt falls into this category.
4. Marketable options:  These are call & put contract in the stock or futures market.
5. Employer’s granted stock options: It’s essentially a long term call option on the given stock.

The only leverages that I recommend of pursuing are mortgage debt and stock options.  The other ones like #1 and #4 are better for professionals.  And the interest rate on #3 is usually too high to be worthwhile carrying, unless it’s for very short timeframe.  The advantage of carrying a mortgage is explained in my post: “Why is your home the best investment?“  #5, the stock options are very good if you are fortunate have them.  Under non-bubble conditions, value of stocks tend to go up along with inflation, and one should be rewarded with certain gain.

P.S.  Be sure to check out comment #1 by Financial Reflections.  He filled in the point that I forgot to make about leveraging other people’s time for internet business.

So, you have decided to become a financial advisor for an average earning of $122,500?  Wow, that’s actually higher than my salary, despite the fact that I think I know more or at least as much about investing than all of the advisors that I have met so far from various big banks and brokerage houses (read my experiences here).

How about going even one step further and become an investment advisor to officially manage other people’s money for fee?  Well, look no further, I have got it all planned out, except I don’t have any potential clients.  Here is a direct route plan to become a small independent money manager in the fastest timeframe:

1. Get your NASD series 65 license & register as an investment advisor in your state.  This will probably cost you one to two thousand dollars, and some annual renewal fees of several hundred dollars.
2. Now you are qualified to open a master account at ScottradeAdvisor.  With this platform from Scottrade, you can essentially open up a money management firm of your own, with very little back-office support.  The master account allows you to have unlimited client accounts.  You can set up various rules for distribution of bought shares into your client accounts, and in a single master trade order, you can buy or sell from all of your client accounts.  Every client accounts are subjected to the same Scottrade commission and fee structure.  You can set up your management fee automatic deduction with Scottrade, with your client permission.  Your clients will own their accounts directly, while giving you the trading authorization and fee deduction authorization.  Since they are the direct Scottrade account holders, this will solve the biggest client trust problem when they give you money for management.  Their accounts will receive the full SIPC insurance coverage up to $500,000.  Plus that you and your clients will enjoy one of the lowest trading commission of $7 offered by Scottrade.  I have personally contacted Ameritrade, ETrade, and TDWaterhouse, and none of them has similiar platform like Scottrade’s.  I know that Charles Schwab has similar service to Scottrade’s, but the trade commission is higher, and they only seem to offer the platform to very big money management firms.
3. Well, that’s it.  You just need to have some marketing plan, and find your clients now.  After that, it’s all about your money management performance, and you will have a very scalable business that can potentially bring you millions of income every year.

Want to be my first clients?  My base fee is only 1%, and I don’t have a minimum opening amount (which is usually north of $100K).  I’m also doing very well, returning about 37% since April 1st of 2005, and returning about 16% since Jan 1st of 2006.  And I didn’t get this performance from a single stock portfolio, but rather diversified among some 60 stocks, most of which has a total return from 35% to 110%.  I will be posting the “brochure” on my website for my own investment firm pretty soon….