Why You Should Regularly Sell Your RSUs
Most folks intuitively understand the risks that accompany a concentrated portfolio. If asked to bet 60-70% of their net worth on a single company, most would refuse, citing it as too risky. Yet many inadvertently do the same by letting their vested RSUs (Restricted Stock Units) accumulate over the years.
The reluctance to sell RSUs is widespread and is not unique to employees of any specific company, or even industry.
Employees grow an affinity with the shares they receiving as compensation. They develop a nearly unshakeable belief that the company’s share price will not only continue to rise but also outpace the broader market and competitors. This psychological phenomenon of valuing something more highly simply because you own it is known as the Endowment Effect .
Other than the Endowment Effect, there are other reasons too why employees do not sell their shares. Some people, for instance, do not regard publicly listed shares as equivalent to cash. They consider their take-home pay as the actual salary and RSUs as just a bonus they receive “for free”. As a result, they don’t treat them with the same care as their regular savings and investments.
Whatever the underlying behavioural reasons, letting RSUs accumulate leads to extreme concentration in your financial portfolio. We have talked about risks associated with betting on your company previously as well when discussing whether to invest in ESPP (Employee Stock Purchase Plan) or not.
Concentration is a double-edged sword: while it can provide abnormally high returns, it also takes you down a bumpy road, and you could still be left behind. By having so much worth in a single company, your financial well-being becomes tied to that of the company.
Downside Risk
We have all heard stories of people who became multi-millionaires by holding on to the company stock over decades. But we never hear of those who lost all their savings because poor management, disruption or frauds led to massive erosion of value.
As the tech slowdown and resulting mass layoffs of 2022-23 taught us, even the top-performing employees at companies considered beyond reproach are not immune to being laid off.
When the company struggles, the share price too gets hammered. Imagine the company stock being down 70%, and losing your job. Not only do you lose the consistent income stream, your savings too, in the form of company shares, could evaporate in a matter of days. Tens of thousands of employees, from top-notch companies such as Meta, Amazon and Paypal, learnt this excruciating lesson the hard way.
Opportunity Cost
Another often-overlooked risk associated with extreme concentration is the potential opportunity cost.
The company stock might continue to increase but may underperform the broader market. By having your money stuck with one company, you lose the chance to potentially make far more money, with less volatility.
The underperformance of individual stocks compared to the wider market is the norm rather than the exception. Since 1926, just 4% of the companies have contributed all of the net gains for the entire US stock market1. 96% of the companies underperformed the index. Thus, the chances that you work at a company that would outperform the market for decades are minuscule.
The Way Out
To avoid this dangerous situation, sell the RSUs regularly and use the proceeds to diversify your financial portfolio.
Remember that even after selling your vested shares, you will not be completely left out from future increases in stock price. You will continue to have investemnts in the company in the form of unvested RSUs. If you intend to stay for a while, and the company continues to perform well, those unvested RSUs should increase in value.
If you sell, what should you do with the sale proceeds? Buy index funds tracking broad market benchmarks like Nifty 50. If you want to maintain exposure to US markets, consider ETFs tracking S&P 500 or the tech-focused NASDAQ 100 index. These diversified funds do not suffer from company-specific risks, and offer much superior risk-adjusted returns than individual stocks. The sale proceeds can also be used to rebalance your portfolio amongst various asset classes such as equity, debt, real estate etc.
Having to decide whether to sell or not, every three months, does not work in practice. You will keep chasing higher prices and never sell. Instead, establish a rule: aim to sell the shares as soon as you get them. If your company mandates blackout periods preventing sales, set reminders.
Now, you can choose to ignore the above and continue holding on to those shares if: a) you believe that company’s future prospects are undervalued by the market, b) they represent a minor portion of your networth (say less than 10%) or c) you are comfortable with the risk of losing it all. But do keep in mind that it will be no different than gambling.