As restricted stock and/or performance grants vest over time, recipients will have a higher concentration in their company stock. Concentrated company stock positions are inherently risky. Even the best of companies can suffer depressed stock prices due to external factors often beyond the control of management. Consequently, it is prudent to periodically diversify and reinvest some of these holdings in a balanced portfolio. Determining when and how much to diversify can be facilitated by simulating the future consequence of different levels of annual diversification.
The following tables and charts have been designed to aid in deciding how much to diversify in the short term in order to achieve the desired level of diversification over the longer term. They show the value of projected holdings in company stock compared to the projected value of a diversified portfolio over time. This sample Share Diversification Analysis is based on the following assumptions:
- Current Stock Price: $70.00
- Stock Price Growth Rate: 5.00 %
- Diversification Percentage: 10.00 %
- Tax Withholding Rate: 25.00 %
- Capital Gains Tax Rate: 20.00 %
- Diversified Portfolio (VDP) Growth Rate: 5.00 %
This analysis models diversification strategies over a 5 year planning horizon. It calculates the year by year “Value of the Diversified Portfolio” (net of capital gains tax) and the value of the Company Shares that result from the “Beginning Shares Owned + Net Shares Vesting” less the “Shares to Sell” (diversify). The various rows are calculated as follows:
- The Share Price row projects the year end company stock price using the current stock price and the estimated growth rate. The first year is prorated based on the date of this analysis: 3/23/2017.
- The Beginning Year Owned Shares + Net Shares Vesting row shows how many shares are available to sell each year. This is the number of shares owned outright at the present time plus the number of restricted/performance shares that are scheduled to vest each year less shares that are withheld for taxes (applying the “Tax Withholding Rate”) and any shares that are sold that year.
- The Average Cost Basis per Share Before Sale row is derived from the original cost basis of the owned shares plus the estimated stock price of the shares vesting each year. Please note that StockOpter Pro can be used to calculate capital gains based on the cost basis for each tax lot.
- The Shares to Sell values are calculated using the “Diversification Percentage” assumption.
- The After Tax Proceeds from Shares Sold is calculated using the share price, the cost basis and the “Capital Gains Rate” (this assumes the shares sold are held for at least 1 year).
- The proceeds from the shares sold are added to the Value of the Diversified Portfolio (VDP) row and the “VDP Growth Rate” is applied to calculate the year-end totals.
- The Value of the Company Shares row is calculated by multiplying the “Share Price” by the remaining company shares.
- The % Company Stock Holdings row shows the percentage of the value of the remaining company shares to the value of the diversified portfolio.
The table data is converted into a graph to illustrate the relationship between the value of the company shares and the value of the diversified portfolio over the 5 year period. It shows the effects of this diversification scenario and whether you are becoming more or less concentrated.
The 2 bottom graphs change the “Diversification %” in '+' and '-' increments of 5% to compare alternative diversification scenarios. This will help determine how much to diversify and reinvest each year.
For additional information on this analysis read the article entitled: Facilitating Owned and Restricted Share Diversification Decisions.