Wealth management is about managing the mind as much as it is about managing the portfolio.
This is especially true when dealing with options, restricted stock, long-term incentive plans and other forms of executive compensation.
Those who hold significant compensation packages need to make themselves aware of some of the subtle (and not-so-subtle) psychological pitfalls this kind of pay can present, and how these pitfalls can potentially leave you in a worse position than before you were granted the compensation.
In order to make clear, rational decisions about your compensation, you need to understand everything you can about them. This begins with you: what are your wealth and lifestyle goals? How does your executive pay fit into those goals? You should also be aware of some of the exercise alternatives available to you and have at least a rough idea of how much your options are worth under various valuation methods.
Finally, you’ll need to understand the tax implications of an options exercise. Knowing these things will ensure your options build wealth, instead of working to destroy it.
Back in the old days of the Internet millionaire, options and other stock-based compensation were seen as the ultimate “get-rich-quick” scheme. Options were often exercised as soon as they were granted, regardless of whether this was the best strategy or not. Most compensation packages of this type have a considerable shelf life (five to 10 years is common) and, statistically speaking, the longer you hold them, the more your potential for gain. If you’re fortunate enough to receive such compensation, teach yourself to avoid “ticker watching” and instead take a long-term view.
Since the financial crisis, wealthy investors have shifted away from a growth-focused attitude and are now placing a priority on risk management. They want to “kick the tires” of a particular investment, and fully understand the risks before they commit their money. They’re looking for full-blown scenario analysis on their proposed portfolios, with verified data that shows them what might happen in the event worse comes to worst. Speaking from my experience, the wealthy individuals I know are more concerned with protecting their downside risk than ever before and are particularly attracted to products and strategies that limit losses in the event of further market turmoil.
Fluctuations are par for the course when investing in the stock market. Those with stock-based compensation need to develop a thick skin, and become accustomed to seeing the value of their compensation – in extension, their net worth – drop during the course of the day. This is particularly true of startups, mining exploration and high-tech companies, where the potential for volatility is so much greater and options are routinely issued as a retention tool.
Options and other forms of future compensation are not cash. They should not be used as a cash substitute.
You should not borrow against them to fund big purchases. Until they are exercised, they are only the potential for wealth and must be treated as such.
Thane Stenner ([email protected]) is the founder of Stenner Investment Partners within Richardson GMP Limited. He is also the author of True Wealth: an expert guide for high-net-worth individuals. His column appears every two weeks.