One of the best ways to accumulate wealth is through investing. Is it any wonder that the richest Americans tend to be heavily invested in real estate and stocks? Since the Bush era tax cuts keep getting extended, investing in stocks has remained subsidized by the government. That's one of the reasons why people like Mitt Romney have a lower effective tax rate than the average taxpayer.
Instead of complaining about how the rich are getting richer though, I try to emulate what they're doing by investing in stocks of my own. Even though I invest in stocks through my retirement accounts, I also took advantage of the employee stock purchase plan (ESPP) at my last company. I worked there for four years and it wasn't until my third year that I was finally able to max out the plan. And as luck would have it, in that third year, our company was acquired by a larger one and the ESPP went away.
Slow and Steady in an ESPP
I learned the hard way that investing in an ESPP is a no-brainer. Our stock, along with the market in general, did very well during the four years I invested. But during those first two years I was too scared to invest more than a couple thousand dollars. Most plans allow you to contribute up to 15 percent of your salary and I was nowhere near that until my third year when a light went off and I realized what a great deal it was.
Normally it's a pretty good idea to invest a small amount any time you're dealing with a new or complex investment. Although ESPPs may seem confusing at first, most of them are set up in a pretty similar way and they're almost always beneficial to the employee. I did what I thought was the smart thing by only investing a couple thousand dollars to start but I really wish someone would have just told me to put all my money in.
It's easy to look back and say you should have put more into certain stocks or done things differently but in this case I think I made a mistake by not maxing out my contribution. My plan worked just like most others in that there was an offering period of one year. At the end of the offering period, the company would buy shares for us using the lower of two prices: the price at the beginning of the offering period or the price at the end of the offering period. In addition to the lower price, we would also receive a 15 percent discount.
At this point, some plans allow you to sell the stock right there but others (like mine) call for a minimum six-month holding period. If there's no holding period, then the decision to max out your plan is already made. You are guaranteed a 15 percent profit on your contributions but a six-month holding period makes things a little more interesting.
Gambling with House Money
The reason companies sometimes require a six-month holding period is because they want you to hold onto the stock. They don't want you to buy and sell, they want you to buy and hold. But if you're like me and you don't hold many individual stocks, then you're going to want out as soon as possible. Initially, I was hesitant to contribute very much because of the six-month holding period and the risk associated with it.
But now that I'm older (by three years) and wiser, I see that even though there was some risk, there was a huge reward for that risk. Not only was I getting a 15 percent head start on the market but being able to take the lower offering period price (beginning or end) made the deal even sweeter. It was almost like I was gambling with a built-in advantage and whenever you have something like that you should take advantage of it.
It's not often that I talk about the missteps I've taken but this is a case where I hope other people can learn from my mistake. I didn't fully understand what I was investing in so maybe it was good I didn't invest too much. I really wish there was someone there who understood the plan and would have told me to go for it.
Readers, what do you think about investing in ESPPs? If you were faced with the same situation, what would you do? Take it slow and steady or jump all in?
Editor's Note: If you feel like you might be making an investment mistake, you can read more articles here on The College Investor and also check out some of the best investment blogs of 2016 to find solutions!