Diversify Your Portfolio: How Startup Employees Over-invest in Tech
Tech as an industry has had major growth in the last few years, and continues to hold strong, even in 2020. However, recent history shows that many tech employees run the very real risk of being too invested in the technology sector. We outline the most common components that make up this overall risk below, and offer some guidance how best to balance your unique risks and opportunities.
If you’re an employee of a venture-backed startup or a more established tech company, you’ll likely be offered stock or stock options as part of your compensation. If your small company grows and reaches a liquidity event, or your large company does well on the public market, there could be a big financial upside, and for many folks, this is one of the most compelling and exciting parts of working in the fast-growing tech industry.
As of June 2020, the NASDAQ, an index with a high concentration of tech companies, is at an all-time high. Despite a tumultuous Q1 across the entire stock market this year, NASDAQ has significantly outpaced the Dow Industrials. This is great news for technology as a sector, but not a guarantee. Now is still a good opportunity to reevaluate your overall investment strategy in preparation for any future changes, whether positive or negative.
Your Income and Your Investments
For startup employees working to get their company off the ground, days are often long and there’s little time to earn outside income. At competitive mid-size or large tech organizations, the workload and expectations are still very high. This means most people in the tech industry depend entirely on their primary employer for their W2 income. While side projects are often popular, those side projects also tend to be tech-focused, given the most common skillsets are software engineering, building SaaS businesses, etc.
When your main income comes from a business in the technology sector and you also invest your funds in tech companies, you’re at greater risk of loss if something happens to adversely affect the performance of this entire sector. A tech bubble burst, for example, could lead to the loss of your job or a pay cut at the same time as your investment account balance falls.
Picking Tech Stocks
As someone who lives and works in a tech hub, you may feel that you have insider knowledge of which companies will succeed, based on exposure and relevant expertise. This can lead to buying stock in primarily, fellow tech companies since those are the companies you know best.
Unfortunately, even having ample knowledge of the technology industry doesn’t protect investors from boom and bust cycles or black swan events. The more exposure to tech within an investment portfolio, the more detrimental the impact of an industry-wide downturn could be.
HCOL Expenses and Real Estate Markets in Major Tech Hubs
In high cost of living areas such as San Francisco Bay Area and New York City, and increasingly, Seattle, Portland, Austin, Los Angeles, Boston, Denver, and others, your cashflow management and investment strategies cannot be the same as they are for people in other parts of the country.
A purchase of a primary residence or investments in a secondary residence or rental properties can be a unique beast in these tech hub markets with extremely competitive real estate markets. Major education expenses for your children, as well as general lifestyle spending is substantially different, and may take up a high percentage of your cashflow, higher than most national averages.
This means general financial planning rules of thumb like “Don’t spend more than 1/3 of your income on rent” or “Have at least 1x your annual salary in retirement savings by the time you’re 30” may not apply to you in the same ways as they would in a lower cost of living metro.
Using Cash to Exercise Stock Options
For those at early-stage startups, it can cost money for employees to actually exercise the stock options that are part of their compensation. In fact, many employees end up needing so much cash to buy into the businesses they work for that they end up compromising other investment goals.
If your early-stage startup allows early exercise and you choose to do it to benefit from favorable tax treatment, you may end up with a significant cash outlay for stock you can’t sell immediately. Likewise, if you leave your company and have to exercise your options within a limited period of time, as most startups require, you’ll also have to come up with substantial cash up front.
This requires some pre-planning, so managing your finances to make sure you have enough liquid assets to take advantage of this potentially high-value opportunity is crucial. Additionally, after you’ve acquired the shares, you will want to holistically review your entire portfolio and diversify your other assets, so that you’re not over-invested in the success of one company (both via your income and your shares) or in technology as a whole.
Diversification and a Personalized Approach
Diversification is essential to minimize risk. With a properly diversified portfolio, you put your money into different sectors of the economy and purchase different classes of assets. By acquiring a mix of different kinds of investments, you maximize the chances that at least some of your money will be invested in a sector that performs well even as others perform poorly, both in the short- and long-term.
It can be difficult to build a diversified portfolio with a mix of investments if you are given the opportunity to exercise stock options that could potentially lead to substantial profit. Many startup employees don’t want to miss out on the chance to own a chunk of shares in the next Uber or Apple and so may be hesitant to entirely pass up the chance to exercise vested stock options.
This is understandable, and you can still invest heavily in tech, as long as you’re keeping a careful eye on your overall portfolio. You do want to ensure that your portfolio isn’t too tech heavy – and can do so by devoting a good portion of your other investment dollars to buying stocks, exchange traded funds, or other custom or alternative investments that are likely to do well when tech underperforms and suited to your general financial goals.
Experienced financial and tax advisors, particularly those that are based in tech hubs and have plenty of experience with clients similar to you, can help you to take a close look at your asset allocation to ensure that you are building a solid portfolio. They can also provide you with assistance in identifying opportunities to find more money to invest if you are tying up a lot of your cash in the purchase of company stock shares, so you don’t miss out on the chance to cash in by working for a startup that gets acquired, becomes involved in a profitable merger, or has an IPO.
- Tax Planning for When Your Startup is Acquired
- Advice on Startup Liquidity Mistakes
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