If you work for a public company then you probably struggle with deciding when you should sell your stock options or RSUs. The data, which we’ll share in this post, clearly says you should sell immediately, but if you’re like most people, that just doesn’t feel right. Perhaps it’s because you feel like you’re being disloyal to your employer (you’re not), you would be embarrassed facing your CEO if you did (she will never know), or you fear the regret you would feel if your company’s stock continues to appreciate. In this post, we use historical data to examine the liquidation decision from the behavioral perspective of regret minimization. Strikingly, we find that the longer you wait to liquidate, the more money you would likely leave on the table.
Do as I Say, Not as I Do
In our previous post we used Modern Portfolio Theory (MPT) to demonstrate that you must expect a very large margin of outperformance relative to a broadly diversified stock index in order to justify holding onto a concentrated position in a single stock. Unfortunately that seldom happens. Based on MPT, the rational action is to immediately sell down your concentrated position and invest in a diversified portfolio.
Ironically even Harry Markowitz, who won the 1990 Nobel Prize in Economics for the invention of MPT, conceded that regret minimization (minimizing the fear that stocks will rise after you sell or drop if you don’t) played a role in his own portfolio choices. Asked in the 1950s how he thought about selecting his own retirement portfolio, he responded:
“I should have computed the … efficient frontier. Instead, I visualized my grief if the stock market went way up and I wasn’t in it. Same if it went way down and I was completely in it. My intention was to minimize my future regret. So I split my contributions 50/50 between bonds and equities.” (Zweig, 2008)
This motivated us to examine the optimal liquidation window for a concentrated position from the behavioral
To examine the selling decision, we compute the proceeds from selling down a $100,000 position in a single stock using various strategies. We measure regret as the amount of return per year you would have lost relative to what turned out to be the ideal selling strategy. We then examine the mean regret generated by each selling strategy when applied to a large sample of firms, to identify the strategy would have minimized your regret from selling down the concentrated position. As was the case in our previous blog post’s analysis, we considered employees who receive stock from companies that recently went public and mature companies that were members of the S&P 500.1
We evaluated 18 different selling strategies over four years for each employee:
- Hold onto the stock for the entire four years
- Sell immediately and invest the proceeds in the S&P 500 for four years
- Sell gradually over 1 to 16 quarters, and invest the proceeds in the S&P 500
For the IPO stocks we assumed that each selling strategy started on the first day following the expiration of the IPO lockup period, which was assumed to take place six months after the IPO. The gradual liquidation strategies sell an equal number of shares every day over a window ranging from 1 to 16 quarters.
To illustrate our analysis, let’s assume you worked for Yelp, which went public on March 2, 2012, and that you had $100,000 worth of company stock. In Table 1, we display the total proceeds, annualized return and annualized regret you would realize from each of the 18 selling strategies.
In the case of Yelp, the strategy of selling gradually over nine quarters realized the best annualized return of 26.6% per year. Regret for our analysis measures the amount by which each of the strategies underperformed the best performing strategy. As a result, the regret for selling over 9 quarters is 0%. By comparison, the strategy of holding indefinitely realized an annualized return of 12.1%, and thus a regret of -14.5% per year.
We repeated the regret computations for every one of the 258 IPO stocks in our sample and calculated the mean annualized regret realized for each of the 18 selling strategies. Figure 2 graphs the mean regrets, with the single dot on the left corresponding to the average outcome from selling immediately; the middle sixteen dots correspond to strategies which gradually liquidate your holdings over a period from 1 to 16 quarters and the single dot on the right corresponding to the outcome from holding onto your stock indefinitely.
As Figure 2 clearly illustrates, on average the strategy that historically came closest to approximating the ideal liquidation strategy (i.e. minimized regret) was to sell the stock immediately. Your regret increases as the length of the window over which you hold your company stock increases, and is most negative if you hold your company stock indefinitely. These results are consistent with the poor performance of IPO stocks relative to the S&P 500 reported by Professor Jay Ritter, the Joseph B. Cordell Eminent Scholar in the Department of Finance at the University of Florida and an academic authority on IPOs.
We repeated the above selling strategy analysis assuming you owned one of the “mature” companies that were members of the S&P 500 at any point during 1997 to 2012 (the segment of the IPO company time period for which we have detailed data on S&P 500 constituents). Again, we calculated the liquidation proceeds, annualized return and annualized regret for each of the 18 selling strategies for each of the 500 members of the S&P 500 starting on their date of inclusion in the index, as long as they remained a member of the index.
The results are illustrated in the Figure 3. Again, we find that on average selling the concentrated position and diversifying the portfolio as soon as possible resulted in the least regret. However, when compared to the set of IPO stocks, the regret associated with any single liquidation strategy is quantitatively smaller.
Sell As Quickly As You Can
The data is awfully clear. You should sell your company stock as quickly as you can. But we’re pretty confident you won’t. To get over your cognitive dissonance, try our suggestion of selling as much as you can up front with the remainder over as short a period as possible, perhaps one year. As we showed in this post it’s not optimal, but it should help.
1The set of “mature” companies is assumed to include all companies that were members of the S&P 500 at any point during the last 20 years; the set of “young” companies includes 258 technology companies that had IPOs from 1990 to 2012 (we stopped at 2012 so that we’d have enough data on post-IPO performance).
Nothing in this blog should be construed as tax advice, a solicitation or offer, or recommendation, to buy or sell any security. This information is provided for illustrative purposes only, and is not intended as investment advice, and Wealthfront does not represent in any manner that the circumstances described herein will result in any particular outcome. Investment advisory services are only provided to investors who become Wealthfront clients. For more information please www.wealthfront.com or see our Full Disclosure.
Backtested performance is NOT an indicator of future actual results. The results reflect hypothetical performance of selling strategies not offered to clients during all time periods studied and do NOT represent returns that any client actually attained. Backtested results are calculated by the retroactive application of a model constructed on the basis of historical data and based on assumptions integral to the model which may or may not be testable and are subject to losses.
Wealthfront assumed Wealthfront would have been able to purchase the securities recommended by the model and the markets were sufficiently liquid to permit all trading. Backtested performance is developed with the benefit of hindsight and has inherent limitations. Specifically, backtested results do not reflect actual trading or the effect of material economic and market factors on the decision-making process. Actual performance may differ significantly from backtested performance. There is a potential for loss as well as gain that is not reflected in the hypothetical information portrayed. Investors evaluating this information should carefully consider the processes, data, and assumptions used by Wealthfront in creating its historical simulations.
Backtested results are adjusted to reflect the reinvestment of dividends and other income and are presented net of fees. Wealthfront did not offer our Selling Plan service during the time periods backtested. Since Wealthfront does not currently charge investment advisory fees for the Selling Plan service, performance does not reflect the deduction of any advisory fees.
While the data Wealthfront uses from third parties is believed to be reliable, Wealthfront does not guarantee the accuracy of the information. The S&P 500® (“Index”) is an index of 500 stocks seen as a leading indicator of U.S. equities and a reflection of the performance of the large cap universe, made up of companies selected by economists. The S&P 500 is a market value weighted index and one of the common benchmarks for the U.S. stock market. The S&P 500 (“Index”) is a product of S&P Dow Jones Indices LLC and/or its affiliates and has been licensed for use by Wealthfront. Copyright © 2015 by S&P Dow Jones Indices LLC, a subsidiary of the McGraw-Hill Companies, Inc., and/or its affiliates. An rights reserved. Redistribution, reproduction and/or photocopying in whole or in part are prohibited Index Data Services Attachment without written permission of S&P Dow Jones Indices LLC. For more information on any of S&P Dow Jones Indices LLC’s indices please visit www.spdji.com. S&P® is a registered trademark of Standard & Poor’s Financial Services LLC and Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC. Neither S&P Dow Jones Indices LLC, Dow Jones Trademark Holdings LLC, their affiliates nor their third party licensors make any representation or warranty, express or implied, as to the ability of any index to accurately represent the asset class or market sector that it purports to represent and neither S&P Dow Jones Indices LLC, Dow Jones Trademark Holdings LLC, their affiliates nor their third party licensors shall have any liability for any errors, omissions, or interruptions of any index or the data included therein.