September 16, 2020 – One question I’ve gotten from readers a few times over the years is whether the participation in a so-called Employee Stock Purchase Plan (ESPP) is worthwhile.

A little bit of background: some corporations offer their employees to buy stocks of their company at a discount of up to 15%. There are some strings attached, though. For example, there are often minimum holding periods, anywhere between a few months and up to two years. The discount is also taxed as ordinary income, though the subsequent capital gains may qualify for treatment as long-term gains.

If you can liquidate the stocks right away and pocket the discount, then participating is likely a no-brainer. Take the money out of the ESPP and invest it in a low-cost index fund. It’s a nice boost to your contributions in your taxable account after you’ve maxed out all your other tax-advantaged options. 15% adjusted by your marginal income tax rate – federal and state. That would still be more than 10% for most people! Pretty sweet!

But what should you do if there’s a minimum holding period? During that time, part of your portfolio is now concentrated in one single corporation. The opposite of diversification. So, it’s a tradeoff: You get the discount but you also take on additional risk. Is it still worthwhile? This is an inherently quantitative question. Without putting hard numbers behind this we can talk about this until the cows come home. The only way to answer this question is through a quantitative exercise. And it turns out, the numbers look like it’s indeed worthwhile to participate in an ESPP, especially if you can get the full 15% discount, the maximum allowed under federal law.

Let’s take a closer look…

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