Financial Planning Challenges for Corporate Executives
By Russell Holcombe, MTx, CFP®
“What do you think?” she asks with a rhetorical tone. I look at the numbers, but we both know what they’re telling us. I respond, “As much as we would like these to be different, there’s not much you can do. The stock is down 30%, and you have 8 more months before the stock vests. I think we both agree it’s too much money to walk away from, right?”
We are hearing this story over and over again this year. With more than 40% of the stocks in the NASDAQ 100 index down 50%, (1) many executives are revisiting their loyalties. But changing teams comes at a cost: leaving unvested stock on the table is certainly easier when the price collapses, but is it going to be better somewhere else?
It’s easy to find general financial planning advice about retirement, savings, and dream planning, but there is one unique component to financial planning for corporate executives that makes planning different: a major component of your pay is tied to the stock price. Your future wealth will depend largely on the success of the stock. With the possibility of a looming recession, rising interest rates, and a wall of corporate debt yet to be refinanced, (2) the next few years could be tenuous for everyone with stock-based compensation. Notwithstanding the complications of “normal” financial planning, the company stock is the bet you are making. Did you pick the right company/stock to get behind? A lot of people are asking themselves this very question right now. Seeking advice is a must and, unfortunately, calling Vanguard won’t help you on this one.
At Holcombe Financial, we work with corporate executives every day, and we understand the unique challenges and opportunities you face. Here are 3 challenges corporate executives must navigate—and what you can do to navigate them.
1. Understanding Your Company Stock
Corporate executives receive payment and incentives in the form of equity compensation like restricted stock units, non-qualified stock options, incentive stock options, and performance shares. While the names are different, they are effectively the same; the performance of the underlying stock price will be a major determination on how wealthy you will become. Understanding your company’s financial statements is essential. Though these can be tough to read, there are a couple items we focus on to help our clients understand the valuation of their company stock and the risk they are taking:
Price-to-earnings ratio: The price of the stock divided by the earnings per share (EPS) is a simple metric and it tells us a lot. (This assumes the company does have earnings—reality is setting in for those that don’t.) Put simply, this ratio tells you how many years it would take to earn back your investment. Ignoring future growth, if the earning per share is 20, it would take 20 years for the company to return the value of your investment in the form of profits. If the company is growing at 10% per year, the breakeven investment period is 12 years. The longer the breakeven period, the riskier the stock. You can visit any finance website to find this number.
Debt-to-asset ratio: Just like on a personal balance sheet, this is the amount of debt as a percentage of total assets that tells you how well a company can handle financial uncertainty. The more debt, the more risk. As interest rates rise, it will be important to figure out how much debt is maturing over the next 5 years. A surprising number of CFOs borrowed money to buy back the company stock, placing all shareholders at risk. Since interest rates are higher now, the risk of refinancing at higher interest rates is real now. Thankfully, everything is public record, and you can find it easily in the annual report. I did a quick Google search for Home Depot’s annual report, located debt on the table of contents, and voilà: Home Depot lists theirs on page 64.
It is important to understand and stay on top of your company’s financial statements, because a significant portion of your current and future wealth depends on it.
2. Are You Overexposed?
This is probably the biggest oversight on the part of financial planners as they advise corporate executives. What percentage of the family net worth is dependent on the stock price and how correlated is that stock to the rest of family assets?
There is a statement among investment professionals, “Rising tides float all ships.” When times are good, all things are good. And when times are bad, the correlation coefficient is 1. Most equity investments are correlated, meaning the financial outcomes are similar in similar economic environments. If the stock market goes down 20%, it is very likely your company stock will be on a similar path. For executives with meaningful tenure, it is not unusual for 30, 40, or even 50% of the net worth to consist of vested and unvested stock benefits. The stock price changes materially affect your net worth, and the stock price changes when the stock market goes up or down in value. But when I look at the “diversified” investment portfolio, it is also exposed 100% to the stock market. Your job, your benefits, and your safety net are all riding in the same correlated boat.
I love the stock market. There is nothing wrong with being 100% invested in stocks. “What if…” just needs to be part of the planning discussion. Because one day they will all be down at the same time and success will depend on staying the course.
A simple equation helps our clients get in touch with their appetite for loss. If you have $3 million and you are 100% exposed to stocks, a 40% market decline is a loss of roughly $1.2 million, so you will have $1.8 million if March 2020 happens again. No wrong answer, it is just an emotional flight simulator to test your appetite for risk. If you don’t like the number, you may be overexposed to stocks.
3. How You Benefit From Volatility
If your plan is like most, the award is based on a percentage of your base compensation. You certainly benefit from the upside, but you can also benefit from volatility in two ways. Both depend on the timing, but the most money we have seen land on the paycheck came from awards that were granted or vested during the Great Recession.
We’ll need a hypothetical to unpack this one: Let’s assume a base salary of $325,000 and a target award at 75% of base salary.
During 2009, many stocks saw a 50% decline in the value of their shares. It was devastating to the balance sheet of many executives. The vesting date arrived and something good happened: the stock vested at half the value of the grant, so the taxation was half of the expectation. Many clients called us, and we recommended keeping the remaining shares if they were comfortable that the company was stable. Essentially, it converted ordinary income to long-term capital gain if the shares were held for one year.
Another good thing happened: the target bonus was awarded at the new lower share price. If the stock was at $20 per share, the target award would have been 12,187 shares. At the bargain-basement Great Recession price, the award would have been 24,375, a 100% increase in the number of shares granted because of a 50% decline in the stock price.
The collapse of the stock price was a financial gift for those that had the stamina to stick with it.
The Bottom Line
At the end of the day, working at a publicly traded company has a lot of benefits—the stock-based compensation plan being one of the most valuable. Choosing which company to work for will have the biggest impact on your wealth. A falling stock price is not the end of the world. You just have to make sure that the company you have picked will be there on the other side. If you’re worried, it may be time to start looking.
Are You Facing Some of These Challenges?
If you’re a corporate executive facing some of these financial planning challenges, we would love to hear from you! To learn more about our comprehensive financial services, schedule a no-obligation introductory meeting to see how we can help by calling us at (404) 257-3317 or emailing hello@holcombefinancial.com.
About Russell
Russell (Rusty) Holcombe is the CEO and strategist at Holcombe Financial, a financial advisory firm serving entrepreneurs and corporate executives and managers. With over 25 years of experience, Rusty spends his days leading Holcombe Financial (a firm his father founded) and providing financial services that help his clients grow and protect their wealth so they can experience financial independence. Rusty is the author of You Should Only Have to Get Rich Once, which has won multiple awards, and created Holcombe Financial’s proprietary financial planning software, which helps clients make smarter financial decisions.
Rusty earned a bachelor’s degree in business administration with a focus in finance and real estate from Southern Methodist University and a master’s degree in taxation from Georgia State University. He is also a CERTIFIED FINANCIAL PLANNER™ professional. In his free time, Rusty and his wife, Regina, tend to their personal farm and grow their own food. You can often find him pursuing his hobby of long-distance running. To learn more about Rusty, connect with him on LinkedIn.
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(2) https://www.spglobal.com/en/research-insights/articles/the-bbb-u-s-bond-market-exceeds-3-trillion