By Dan Trumbower, CFP
Executive compensation incentives offer a wonderful planning opportunity to build wealth - if you take advantage of that opportunity with a clear head and sound strategy. In my 20 years of advising executives of Fortune 500 companies and their families, I have come across several common and avoidable pitfalls. Had my clients made the wrong choice, it could have cost them a small fortune in tax liability and the opportunity cost of missing out on valuable diversification opportunities. I cannot stress enough the importance of working with a fee-only fiduciary advisor to help you create a strategic plan while staying disciplined along the way. Here are a few areas that you can evaluate with your wealth advisor in light of your overall financial picture.
Mistake #1: Betting the Farm on One Company
Zoom out of the big picture and examine the risk that your company plays in your financial life at a macro level. If the market value of your company were to suddenly and substantially decrease, what would happen to your monthly cash flow? Perhaps layoffs or furloughs are on the horizon. How about your investment portfolio filled with company stock? The value of your stock options or restricted awards are now worth far less than you had anticipated.
Even if you are totally confident in the strength of your company’s prospects, being overly dependent on a single financial driver puts you and your family in a “risk on” position. The simple truth is that nobody knows what will happen tomorrow. There are so many variables at stake that are out of your control. Perhaps your company is hit with a devastating data breach, an accounting scandal or an unsuccessful Phase 3 clinical trial. My advice to you is to “control what is within your control”—diversification, customized portfolio allocation, tax efficiency and limiting investment expenses and transaction costs.
Once you and your advisor develop a diversification plan, the key is to maintain discipline with your strategy and take the emotion out of it. Do not allow short-term events in the company or the markets dictate your thinking. A solid trading program would likely involve gradual and targeted outright sales at specific price points coupled with trailing stop limit orders for downside protection, while not capping your upside.
Many times executives will give consideration to more complex hedging strategies using put and call options. Before this is even up for discussion, be sure to check with your company’s trading policy. Chances are you cannot engage in derivatives in your own company stock – or perhaps even ETFs in the same industry. Also, make note of any other trading restrictions such as blackout periods.
Mistake #2: Tax Inefficiency
Your portfolio should take tax efficiency into account at every level- from the positions you own and which accounts these assets are located. For example, consider tax loss harvesting during market downturns. The fastest bear market in history during March/April 2020 turned out to be a perfect time to take valuable tax losses and reposition into securities bound to recover over the long term. If your advisor is not being proactive when these valuable opportunities come along, perhaps it’s time to reevaluate that relationship.
Mistake #3: Not Making the Most of Charitable Giving
Wealthy executives don’t write checks! They donate appreciated securities “in-kind” directly to their qualified charity or to a donor advised fund (DAF). If you are already taking required minimum distributions from your IRA, a qualified charitable distribution (QCD) is also a great way to complete your charitable giving (up to $100,000/year) while reducing taxable income at the same time.
Avoid these key mistakes and you’ll be ahead of the game, with more left in your pocket to grow and compound over the long term.
About the author: Dan Trumbower, CFP®
Dan Trumbower, CFP® specializes in executive compensation strategies and is Senior Wealth Advisor at Halpern Financial, a fee-only, independent, fiduciary wealth management firm in Rockville, MD and Ashburn, VA.