Restricted Stock Units and Building a Diversified Portfolio

Your compensation package likely includes more than just a salary — it probably features equity-based incentives like Restricted Stock Units (RSUs). While RSUs can be a powerful wealth-building tool, they also come with taxation, timing, and risk management complexities.  

Strategies to maximize your RSUs

First, there’s much more to this than just waiting for vesting. Strategic planning around when to sell, how to manage taxes, and what to do with the proceeds will help you get the most out of your total compensation package. 

Timing your sales

So, your RSUs vest. Now what? You must decide when to sell the shares. Timing is critical. If you sell your shares immediately, the difference between the vesting and sale prices may be minimal, but it will still be taxed as ordinary income. Holding onto the shares for more than a year could allow you to take advantage of long-term capital gains tax rates—usually lower than ordinary income tax rates.

Let’s go with an example. If you receive a vest in mid-February as part of your pre-set Restricted Stock Vesting schedule, the shares that you receive will automatically have tax withheld, so if you sell right away, you can move these positions to cash in a very efficient way: the difference between your cost basis (price at acquisition) will be nearly the same as the fair market value of the shares when sold.

In turn, shares received that are held for over a year can create a favorable tax situation when sold – with profits taxed at capital gains rates and /or losses taken that can offset future capital gains. 

However, holding onto your RSUs also carries risks—mainly the risk of your company’s stock price declining. Strike a balance between tax efficiency and managing market risk.

Understand what portion of your investable net worth is allocated into single stock concentrations on a percentage basis. The correct percentage balances your capacity for risk with your other priorities. A great way to think about this is that if you have a 30% concentration in a single stock, thirty cents of every invested dollar you hold is subject to the market movement and volatility of the position on any given day in the market. Stock concentrations can create wealth but cause volatility that can increase value swings across a portfolio.

Managing tax withholdings 

At vesting, your employer will withhold a portion of your shares to cover taxes, typically at a flat rate of 22-37%. This withholding is often insufficient for higher earners, leaving you with a potential tax bill come filing time. One strategy to mitigate this is increasing your payroll withholdings or making estimated tax payments throughout the year. 

Sell to cover when RSUs vest

Another approach is selling a portion of your restricted stock units immediately upon vesting to cover additional tax liabilities. This “sell-to-cover” method can help avoid dipping into your savings during tax season. 

The IRS requires taxpayers to pay or withhold taxes as income is earned, specifically 90% of the tax you owe for the current year or 110% of the payment owed for the previous tax year (to be deemed in “Safe Harbor”). If you withhold taxes at the time of vest, you may be subject to higher quarterly estimated tax payments throughout the year

Using RSUs for immediate financial goals

Sometimes, selling your RSUs as soon as they vest makes sense, especially if you have immediate financial needs. For instance, if you’re looking to fund a major purchase, pay off high-interest debt, or invest in new opportunities, RSUs can efficiently generate cash without tapping into other assets. 

Avoiding overconcentration in company stock

While RSUs offer the potential for significant wealth creation, they also come with the risk of overconcentration in a single stock — your company’s. 

Many executives who wish to divest shares throughout the year but are subject to blackout trading windows can make a 10b5-1 trading plan, which allows for pre-set transactions to occur throughout the year based on the timing and price of a security. 

Risks of over-reliance on company stock

Company performance can be volatile, and any decline in stock value could significantly impact your financial well-being. We’ve seen this in the past with companies like Enron, where employees with large amounts of company stock lost their jobs and their life savings. 

How much company stock is too much? 

A common rule of thumb is to keep no more than 10-30% of your portfolio in your employer’s stock: Determine your target by your circumstances, time horizon, and portfolio goals. Identifying a target allocation limit will allow you to benefit from the company’s success while keeping a better sense of your overall exposure. If your holdings exceed this threshold, it’s a good time to consider diversifying.  

Building a diversified portfolio around RSUs

Diversification is essential for reducing risk and smoothing out returns over the long term. While your RSUs can be an essential part of your financial strategy, don’t rely on them exclusively. 

Asset allocation strategies

To build a balanced portfolio, consider investing RSU proceeds into other asset classes such as bonds, real estate, private equity, and international stocks. The goal is to spread your investments across assets that perform differently under various market conditions. 

For example, suppose your company stock represents a significant portion of your equity holdings. In that case, you might want to increase your exposure to fixed-income assets like bonds or real estate to offset potential volatility in the stock market.

Working with a financial advisor to identify your financial goals, time horizon, and anticipated cash needs from the portfolio is a great way to help create a strategic asset allocation as a guideline for investing and periodically rebalancing assets across your portfolio.  

Leveraging tax-advantaged accounts

Consider using tax-advantaged accounts such as 401(k)s, IRAs, and Health Savings Accounts (HSAs) to reinvest your RSU proceeds. These accounts offer tax benefits that can help reduce your overall tax liability and increase your wealth. For instance, you can use RSU sales to max out your retirement contributions or contribute to a backdoor Roth IRA if your income exceeds contribution limits for traditional IRAs. 

Aligning RSUs with your long-term goals

Maximizing RSUs is not just about minimizing taxes or selling at the right time. It’s about incorporating them into your broader financial strategy — think retirement planning, wealth preservation, and legacy planning.  

Restricted stock units are valuable parts of your compensation package, but maximizing their potential requires strategic planning. By timing your sales, managing taxes, diversifying your investments, and aligning with your long-term financial goals, you can turn them into a powerful wealth-building tool that supports your financial security and legacy.

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