Assuming NQOs, exercising and selling generates a big tax hit (ordinary income, not capital gains). That tax hit will dilute the amount available to diversify. For example, if I am $100k above water in an NQO and I want to diversify, if I liquidate that option I will have say $70k left to reinvest. Basically I can have $100k plus strike price effectively invested through the options or $70k invested elsewhere.
The tax is going to get you eventually. Unless the price falls, of course. Exercising will be taxed in a higher bracket, probably, since people who get lots of options are probably also making a decent amount.
I didn’t exercise when I should have because of the tax. Some people get lucky, some don’t. I didn’t.
I exercised when I shouldn’t have because I didn’t think the stock could possibly keep rising at the rate it was going. I was very wrong and left millions on the table.
Hindsight is 20/20, YMMV, etc. I just know there are some exercise strategies that can kill you. I still made out ok, but still…
One of the problems is that people feel “I didn’t sell and ended up with a $50k loss” much more strongly than they feel “I sold, and later found out I could had a $50k gain if I didn’t”. Which may be entirely rational – most people’s financial situation is more impacted by an unexpected big loss than it is by a forgone unexpected big gain – but if you’re looking to maximise expected outcome, one is the same as the other.
Very true, and trying to maximize expected outcome seems equivalent to timing the market, which we all know is a bad thing.
After this my daughter became an expert in behavioral economics (actually judgement/decision making) and I learned a lot. I screwed up in 2001 but I didn’t screw up in 2008.
The nice thing about option grants from an employer is that you have to make some spectacularly poor decisions to actually lose money, generally from confusing incentive stock options (ISOs) and non-qualified options (NQOs) which have dramatically different tax rules. Even then you need a good dose of stupidity or hubris to pull off the loss.
This has been a great discussion. Thanks everyone.
It’s our lottery ticket, and we know it. I’d wager there’s better than even odds that we never make a dime on them. Certainly that’s what happened with mine.
On the other hand, my wife has a cousin who worked for a company in the late 90s that was acquired by Cisco. His options all converted immediately to Cisco stock. He never worried about money again.
There’s one aspect of “timing the market” we can get behind: Generally stocks increase in value over time, so all else being equal, exercise your options at the last possible moment before expiry.
I wasn’t in a position to screw up (or not) in 2001, but did the right thing in 2008 in that I increased my 401k withholdings and let it ride rather than trying to find be bottom, I guess that is some general “trying to time the market” in the sense of “stocks are generally depressed now, so I will generally buy more”.
The thing that gets me is that, absent tax implications, the questions “should I hold on to this stock I already own?” and “should I buy this stock that don’t yet own with cash I currently have?” ought to always have the same answer, but usually don’t.
However, as I mentioned upthread, biotech/pharma startups tend to go through several boom/bust cycles on their way to their ultimate fate. They hit milestones and investors rush in. They miss deadlines and investors rush out.
You can’t predict when these things will happen for any given stock, but they almost always do. And if they’re following the rules, you can’t know what’s coming because clinical trial data is generally blinded, so even the people running the trials don’t really know how they’re doing, unless something huge happens like people walking away from their deathbeds (or the opposite).
Stocks in general go up over time. A stock in particular does not. (Ask the Enron employees.) This is the opposite of diversification. And putting an arbitrary date on when you sell is timing the market squared.
I’ve given up owning individual stocks, because if there is some change in the market there are algorithms out there that respond to it in nanoseconds. I want them on my side. I’m willing to pay for that.