Are Your Finances At Risk If A Bear Market Takes A Bite Out Of Your RSU Income?
When you accept a position at a large tech firm (and perhaps even more so at a startup), a material component of your total compensation is likely in the form of restricted stock units (RSU's) or other equity such as incentive stock options (ISO's). In some cases, your equity may represent a bigger (potential) number than your base salary.
Having large blocks of company stock vesting every quarter or every 6 months can turn a solid 6 figure base salary into total annual compensation closing in on a half-million dollars (or more). For the past 10 years, the stock market has steadily increased with notable drops, such as what happened this past Monday (8/5), coming very infrequently. The technology sector, led by the super heavyweights (Apple, Google, Facebook, Amazon, etc) that employ tens of thousands of Bay Area employees, has realized a disproportionate share of the bull market gains. In that environment, if you planned your expenses based on the stock value on the grant date, by the time the shares vested the stock price was higher and you had additional income to spare. So, where's the problem statement in all that?
When the tech boom eventually comes to an end and these high flying stocks temporarily fall out of favor, their share prices fall, and the companies become more cautious on future grants, the fountain of excess income may run dry. Notice that I said temporarily fall out of favor. This is not naively taking a "glass is half full" view on the volatile beast called the stock market. This is leaning on the indisputable evidence of the long-term upward trend that the market has delivered to patient and disciplined investors. Also notice that I didn't say "If" the tech boom ends. History tells us that a bear market, defined as a drop of 20% from the recent high, comes about once every 5 years. No predictions, but at 10 years and counting it's hard to say we aren't overdue for a bear sighting. And when he does show up, which sector do you think will feel a disproportionate share of his wrath?
Click HERE for a graphical summary of bear and bull markets over the past ~100 years.
Source: First Trust Advisors L.P.
Ok, I get it....stocks are risky in the short-term. So how should I manage my expenses before the big bad bear takes a bite out of my RSU income?
A good rule of thumb as it relates to RSU's or any other variable income:
- Use your salary to plan for regular or recurring expenses: this would include your mortgage/rent, groceries, utilities, childcare, etc.
- Use your RSU's for one-time expenses or to make lump sum contributions toward important goals: a vacation to New Zealand, upgrading your 10 year old car so your Tesla driving neighbors will stop making fun of you, sending your parents to a destination that they've always wanted to visit, opening and funding your daughter's 529 account, contributing to a charity or political organization that you believe in or knocking out the home renovation that has been on hold for a few years....to name a few.
What you should NOT do is upgrade your recurring expenses to a level where you are now relying on the variable RSU income to make ends meet. So, don't base your home buying capacity on your total income and put your family at risk of being house poor. Resist the urge to increase the frequency of eating out 1-2 times per week to 1-2 times per day (food is the silent killer in many budgets). When it's time to replace the vehicle, let the actual value of the vested RSU's dictate the budget instead of committing to a car payment based on what eTrade tells you the potential value of unvested shares will be when they vest 12 to 24 months from now.
If you have a specific goal or intended use for the unvested RSU's, doing a little "what if" planning can be time well spent. Perhaps your base case scenario uses the current stock price. If the intended use is a family vacation to an international destination, the base case might be 7 days in France flying coach and staying in a budget-friendly hotel or Airbnb. When it's time to book and the now vested shares are worth 25% more than the base case, perhaps you fly first class and book a room with a view of the Eiffel Tower. Sweet! On the flip side, if the market is in bear territory, maybe you do a road trip to a few national parks and save the Tour de France for next year when odds are good that the market will have rebounded.
Telling your family that France will have to wait until next year might be unpleasant, but compare that to carrying the weight of a mortgage that you signed up for on the assumption you would bring home $500k and in reality this year it was a little under $400k.
It's important to treat those wonderful RSU's like icing on the cake and not the cake itself. After all, cake with no icing is still pretty darn tasty, but if you lose the cake...well that just sucks.
If you want help managing your RSU income or the complexities it brings to your budget or taxes, reach out to me at ron@rivermarkwealth.com or schedule a complimentary consultation.