Get Free Money - Use Your ESPP
One of the most awesome employment benefits you can have is an Employee Stock Purchase Plan. Most of the time, contributing to them is the equivalent of getting free money. Most of these plans give you a discount on the price and many have a look-back provision that makes them even sweeter. Buy one day. Sell the next. Make 15%.
ESPP Basics
Employee Stock Purchase Plans are programs that allow employees to buy stock in the company they work for, usually at a discount. They all have their own rules set by the company, but there are usually commonalities among them:
- Provide for a discount on the price. The discount will vary, but 15% is not uncommon.
- Have a look-back provision. A look-back sets the your purchase price at either the day the purchase cycle ends or the day it began, whichever is lower. In other words, if your plan runs every six months, you’ll buy at the lower of the January 2nd price or the June 30th price.
- No restrictions on how long shares must be held. This one is key. Ideally, you can sell the next day. Sometimes the transaction takes a few days. Worst case, you have to wait for several months.
Take the money and run
Here’s how the free money works. It’s too simple. As soon after your program buys shares for you as you’re permitted to, sell them. At minimum, you make an immediate 15% (or whatever your discount is) profit. It could be even better using a look-back provision. In that case, it’s possible your discount (and hence, profit) would be even higher.
What I’m advocating is derisively called ‘flipping.’ Some people say it’s an abuse of the system. To which I have two things to say.
- They set up the rules. I’m just playing by them.
- Do you really expect me to keep an inordinate amount of a single stock, in the company I work for no less, in my investment portfolio? That breaks, like, rule number one of investing.
Our experience
My wife worked for a company that had an ESPP. The discount was 15% and it had a look-back provision. We took a slightly different tack than what I’m advocating here, simply for tax reasons. We waited until we’d held the stock for a year to take advantage of long-term capital gains tax. Though in retrospect, it probably didn’t make any difference because of our taxable income.
The beauty part is that, because the money for the ESPP came directly out of her paycheck, we never even missed the money. So every six months was another windfall. If I remember right, we used the bulk of it to pay for her MBA program.
Bottom line, if you have an ESPP available to you and you don’t participate, I think you’re a turning down free money. And turning down free money is dumb.
benefits
August 23rd, 2007 at 3:58 pm
> Worst case, you have to wait for several months.
Just be sure the purchase discount makes up for historical short-term volatility in the stock. Otherwise I wouldn’t do this with much money.
August 23rd, 2007 at 8:25 pm
I totally agree, with one minor quibble.
You are *not* guaranteed 15%. Usually the sale date is a day or two *after* the purchase date. Therefore it is possible to make money or, in pathological cases, even lose money.
But the risks of that are very small, and generally the rewards are very high. This period, my buy price was about $17 and my sale price was about $23. Not too shabby!
August 24th, 2007 at 1:28 pm
I am in the process of writing a book on Employee Stock Purchase Plans (it will be available from www.nceo.org later this year). You are correct, they can be a great investment. It is also true that the terms and discount vary widely from company to company.
The 15% discount mentioned can be significant higher if the plan has a “look-back” provision. These are plans where the purchase price is based on a discount of the lower of either the grant date (the beginning of the contribution period) or the purchase date. For about 50% of companies this period is six-months. This means that you may be purchasing using a discount MUCH higher than 15%! Due to recent changes in accounting rules some companies only offer discounts of 5% off of the purchase date price. These plans can be riskier than monthly dollar cost averaging if the stock price tends to be volatile.
If the plan qualifies under IRC 423 (most plans structured like those above do) then you can end up receiving significant tax savings if you hold the shares (at least 2 years from the date of grant and 1 year from the date of purchase). If your discount from the purchase date price is extremely high, this potential tax saving can be a good reason to consider NOT flipping your shares.
You should look at each purchase separately and determine a strategy based on the facts and circumstances of the purchase. These plans do offer an amazing benefit and it never ceases to amaze me that many companies have participation rates of less than 25%.
September 8th, 2007 at 8:53 am