Tech workers profiting from stock options should avoid these costly mistakes

Technology workers whose compensation includes stock awards may have seen an increase in their net worth due to the continued rally in technology stocks this year. But if they cash out too quickly, they could face unintended tax consequences and miss out on future profits.

The Nasdaq Composite index is up more than 20% this year, led by tech giants like Apple (AAPL), Alphabet (GOOGL), Metaplatforms (META) and, most notably, AI chipmaker Nvidia (NVDA), which is up 170% this year and has reportedly minted millionaires within its ranks.

Investopedia spoke with David Amann – a former technology executive and now financial advisor at Edwards Jones who works with stock-based compensation clients – to find out how employees can navigate market volatility, figure out diversification, and what mistakes to avoid if they’re too deal with stock options.

Here’s an edited excerpt from that conversation.

INVESTOPEDIA: Do you know people who are millionaires from the stock compensation they have? What are some of the mistakes they make when trying to make money so quickly?

Before becoming a financial advisor, I personally worked for Netscape when it went public in 1995. I had a front row seat to see what can happen if you don’t follow certain important guidelines, such as diversification and ensure you fully understand your stock compensation.

When I worked at Netscape, stock compensation felt a bit like a lottery ticket. I didn’t think about it as part of my long-term strategy. I was sure I would retire somewhere on a Greek island.

INVESTOPEDIA: What were some of the tax mistakes you made?

When it comes to stock-based compensation, I think it’s really important to work with a tax professional, and I certainly would want to.

Some types of stock compensation, such as incentive stock options or a stock purchase plan for the employer— can give you tax benefits if you hold it for certain periods. Others, like restricted stock units (RSUs) or non-qualified stock options do not necessarily have the same benefits. It can get very complicated.

That said, I don’t think people should let the tax tail wag the dog here. I’ve seen too many people focus solely on the tax benefits of their stock compensation and forget about other critical factors such as diversification or how volatile the underlying stocks can be.

INVESTOPEDIA: What kind of advice do you give to clients who have a large portion of their compensation in stock options and there is market volatility?

When I think of stock compensation for employers, it’s about using those assets to achieve some meaningful long-term financial goals, like (saving for) your child’s education or paying property taxes.

When we think about buying or selling stock options, we first want to think about that (long-term) strategy. Whether or not people should buy or sell is determined by what (one’s) goals are (and) what they are trying to achieve.

INVESTOPEDIA: In general, what proportion of people’s portfolios should they have allocated to their company’s stock?

You should always remember that you are not only investing in your own company stock, but you are also receiving your salary from that company.

At Edward Jones, we generally apply the rule of thumb that no one should have more than 5% of their investable assets in a single investment. When considering stock-based compensation, you may want to go even lower than that. If your company is going through tough times, not only will your stock-based compensation be worth less, but there is also a chance of layoffs, which will impact your employment situation.