Some Thoughts on Debt Aversion and Employee Stock Purchase Plan

After several years of being debt-free (apart from the mortgage), we now have an auto loan. A rather huge one at that :( And it is driving us nuts. This is in spite of the fact that getting the auto loan is a well-thought out decision. Over the past year, we knew that our old car would die sometime soon and we needed to save to buy another car. And we did save quite diligently. But every time the cash reserve crossed $5K, we consciously made a choice to invest it, since in the long term a higher interest rate and the compounding of our savings account will yield far better fruits than the interest we have to pay for the car loan in the short term. The auto loan we have is at 5.25% and most of our investments (knock on wood) are doing better than that.

That said, a loan is a loan. And we hate it :(

So last week, I sold the stock I have purchased over the past year by participating in the employee stock purchase plan and applied it to the car loan. Here are some thoughts on the reasons for our decision and about debt aversion in general.

Most advice I have read, says not to own the stocks in the company you work for
In other words, don’t put all the eggs in one basket. If the company goes bust, you not only lose the job security but also a lot of your savings. Unless the company is doing very, very well and you know with a high level of certainty that you can make positive earnings on your stock, it is better not to put too much of your savings in the company stock. My company allows us to purchase stock worth 10% of the salary via the employee stock purchase plan and I have always participated to the maximum extent. That is a significant amount of money that I did not feel comfortable leaving in the company stock since the company has not been doing too well of late.

I got pretty good returns on my investment by selling when I did
The way they calculate the purchase price for the employee stock purchase plan is to take the lowest of the price on the starting date and the ending date of the purchase period and offer a discount of 15% on that price. The best way for me to take advantage of participating in the plan, since I don’t foresee a huge bump up in stock price any time soon, is to materialize the guaranteed 15% return. Also, fortunately for me, the day I sold the stock some industry news temporarily bumped up the price resulting in an overall return close to 25%!

Taxes suck :(
Even though the overall returns look good, we don’t really make that much since taxes take a huge bite out of it. If we had hung on to the stock for a year, it would have qualified for being taxed at the rate of capital gains. But because we sold early, it gets taxed as regular income. Boo.

Debt aversion can be a nasty thing
When we had the check for the money in hand, we had several options of what to do with it. We could reinvest it in diversified index funds or in real estate back in the home country that will most likely yield far better gains than the 5.25% we are paying for our auto loan. Or apply the amount to the emergency fund since we know for a fact that we will soon have some huge medical bills and there isn’t enough in our emergency fund to cover it. Or save it for travel expenses, since we plan on visiting our home country soon and the trip costs a lot! But the thought that is the foremost in our minds was the auto loan. So we decided to apply the whole check (with some additional amount that we added!) to bring the auto loan down by about 35%. I don’t know if it was the smartest thing to do, but boy it felt good to see the auto loan shrink :)

I just don’t understand why some people do not participate in the employee stock purchase plan!
Soon after the stocks for this period were granted, during lunch when we were all talking about it one of my colleagues revealed that he does not participate in the stock purchase plan! I was quite stunned. I am not very close to this person, and in my personal life, I tend to keep my mouth shut when it comes to other people’s finances, so I did not ask him why. But I can’t help but wonder. What motivates an otherwise perfectly smart person to make such a dumb decision? If the company allowed me to put more of my salary in the stock purchase plan, I would, even if it meant I would have to cut some corners due to a reduced take home salary. 15% of guaranteed returns (minus the taxes of course) is no joke. And still here was a perfectly sensible person saying no to that kind of returns. Why?

What do you do with the stock purchased through your employee stock purchase plan? If you don’t participate in the employee stock purchase plan in spite of you company offering one, will you please explain to me why not? And do any of you get so emotional about debt that you are willing to do anything to get rid of it? It can't just be us making some financially stupid choices! :)

*Image credit: Student Action Network

If you like this article, you can bookmark it or subscribe to the feed.


The Dividend Guy said...

I too cannot understand why people do not participate in their company's ESPP. I do and it has been good. However, I treat it like I would any stock in my portfolio - I try to keep it to no more than 10% of my overall portfolio and when it does, I sell it and redeploy the money into other stocks. It is not my spending money (for a long time anyway). I also have stock options which further complicates things as I beleive I need to consider this as part of the holdings in the company.

SJean said...

Well.... here i am, someone who doesn't participate!

I think there are two reasons. I'm not well informed as to why (15% guaranteed returns? how so?) I should. And two, I'm still building my efund, etc.

But, this is why I read pf blogs! I'm going to look into it. Thanks!

SJean said...

Oh, our company only does a 5% discount. Is that still a "can't pass up" deal?

ispf said...

Dividend guy: That is a very sensible strategy! I know we should be doing something like that. I think the attitude really matters too! We have always looked at ESPP as a means to hoard some money for short term needs and so we didn't feel too bad about selling the stocks (even though I am a bit spooked by the way we utilized the proceeds based on emotional reasoning instead of solid financial reasoning!). I think if we slip into the attitude that it is "not our spending money" we will do far better in the future! Thanks for your comment and triggering this line of thought!!

SJean: The 15% guaranteed returns (minus taxes) is based on the calculations that our ESPP offers a 15% discount. In your case, with only 5% discount, I am not sure if it that hot a deal. Especially since it will be taxed as regular income if you sell in less than one year. But I wouldn't give up on it just yet. How is the stock price calculated? In our case, it is lower of the stock price on the starting and the ending day of the offer period. Consider for example a 6 month period of Jan 1 to June 30. Then the stock price on Jan 1 and on June 30 are considered. The lower of these two prices is selected and our stocks are purchased at 15% discount from this lower price. So if the stock price was significantly lower on Jan 1 than on June 30, since we get our stocks on July 1st at 15% discount from the price on Jan 1st, we can make a tidy profit. On the other hand if it is lower on June 30th, we don't lose much, since it is at 15% discount anyway. So pay particular attention to how your stock price is determined, and what the 5% discount comes off of.

xshanex said...

I completely agree as well. Where I worked 3 years ago people must have had Enron in their minds way too much even though we were working for a employee owned company on very solid financial footing. I was contributing to my 401k but also chose to contribute to the ESPP program which sold us stock at a 20% discount! I am still kicking myself for not taking advantage of that more while I was there. Over 2 years the stock performed very well and I ended up making 35-40%(20%+15-20%) when rolled it over after I quit. I was bummed that my current company used a more complex options program and didn't have ESPP. My new position was a substantial pay raise which negated the ESPP program. The former company went public and I knew several people who had been with them for 10+ years and had taken advantage of the paid off a house and it moved up a few people's retirements several years

ispf said...

xshanex: 20% discount on ESPP is awesome!!! And if the stock went up by another 15-20% that is so much better! It is times when I hear stories like this that I wish I had joined a smaller company with better growth prospects :) Being able to pay off the mortgage with the ESPP stocks seems like an incredible dream come true!!!