Monday, September 3, 2012

Blueprint for getting rich – Part V

This is one of the last posts in our Blueprint series. We’re revisiting the windfall of employee savings plans in Part III. The implied assumption of the employee savings plan post was that a person would stick around at the same place of employment for 20 years or longer. That is in today’s world not a realistic expectation. Also the assumption that the employer’s share price would increase year in and year out an average rate of 10% is not realistic. Many companies don’t last more than 5 to 10 years before they are merged, are taken over, or are biting the dust.
Thus, we should see the employee savings plan as part of our overall portfolio and rebalance it from time to time. Most mutual funds and sophisticated investors do not have much more than 5% of their total portfolio invested in a single asset. That is a good rule of thumb for a passively managed investment but when you are closely involved with the investment such as being in control of your own company this rule is not very practical. Just ask Bill Gates. In fact most big fortunes are made by actually focusing your portfolio on one or a few investments where the investor has a lot of control. That is why there are so many real estate millionaires because they can invest a larger portion than 5% in a single investment asset.
When you are employed at your investment but are not in management or better senior management you may know a fair bit more about your work place than the typical passive investor but you have a lot less control or no control about how your place of employment is being run. Thus your portfolio can have more than 5% of its assets invested in your place of employment but at 30% or higher I would get worried. Sometimes it cannot be helped and your savings plan may exceed the 30% limit anyway. If that happes you should be on top of your holdings - ready to pull the sell trigger. This is especially ture when dealing with stock options, which we have not discussed in this series.
If you happen to work at a company that is booming in the stock market take from time to time some of the money off the table. Set a target price say 10% above today’s price. When your holdings increase beyond a 30% of net worth and trade above the target price cash some in and invest it in something else like an ETF or real estate (it all depends on the market). Then increase your target price by another 10% and repeat the process.
But all good things come to an end and thus make sure you’re not too greedy and end up left holding an empty bag. If you end your employment then be ready to reduce your holdings to the level of a normal passive investment, i.e. to a maximum of 5% of your total net worth. You don’t have to do this all at once and you can take advantage of price rallies to determine selling off more of your holdings.
Most employee savings plans have rules as to vesting. An employer’s contribution to your savings plan may not be yours right away, you are likely required to keep it in the savings plan for a specific period of time before you can take it out. It depends on the plan but typically you have to hold on for a year. This encourages you to stay with your current employer just a bit longer. Normally waiting for your employer’s contribution to vest is no problem because you made on your contribution basically a 100 to 150% return by holding on for the duration of the vested period plus any dividends and appreciation you earned on your and your employer’s contribution.
But after that first year, you can do with the proceeds what you want. So if your employee savings plan value exceeds your maximum portfolio weighting, take it out and put it in another investment account(s) – a TSFA or a RRSP or a non-tax sheltered account or in real estate. Your place of employment is not the only place where you can make 10% ROI per year so there is nothing to stop you from diversifying your holdings.
If you follow this strategy during your entire career then the total return will likely resemble that as outlined in part III of this series.

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