How to Handle RSUs: Understanding your Emotions
There are a plethora of guides on how to handle RSUs from a financial planning and tax efficiency perspective. However, few have taken a look at what actually drives people’s decisions. Emotions.
In a recent blog post, we discussed how RSUs are income in the form of your employer shares. Unlike any other form of income like salary, bonus, commissions, or tips, when it comes to RSUs, your income is completely dependent on the one thing that nobody can control, market perspective.
Your entire RSU paycheck is at the whim of what the market thinks of your company and what the market thinks of itself. And at the moment that your shares vest it’s up to Mr. Market to dole out his judgment and tell you what you get paid.
This market dependence, from the beginning of your employment to the end, and beyond, is what makes navigating RSU decisions so difficult.
The best weapon you have in the fight against bad decisions is understanding how those decisions are being made.
Below is a list of a few common behavioral biases that we are faced when wrestling with the decision of how to handle RSUs and how to potentially overcome them.
How to Handle RSUs: Anchoring
What is Anchoring
Anchoring is our fixation on an original piece of information. It usually has something to do with a number or more specifically, value. Anchoring, as the term implies, fixes our future decisions far too heavily on this original piece of information. This bias inhibits us from taking in new information and applying it to our decision process.
How it plays out in RSUs
When you get your initial grant, you will also get a full valuation of the grant if you stay long enough to see it all vest. If you are with a privately owned company, it will be an approximation based on the most recent 409a fair market valuation. If you are at a publicly-traded company, it will simply be the market price of the stock at the date you chose to look at your grant.
This number will dictate how you feel about the value of your RSUs going forward. Are my RSUs worth more now than before? Great. Are they worth less? Awful.
This thought process will usually be the starting point of your evaluation when deciding to sell or to hold.
How to fight it
To overcome anchoring you need to evaluate the price of your company stock and your own financial situation.
Evaluate the company and ask why is the stock price higher or lower than before? What has changed? Was the IPO overhyped? Is a new competitor stealing their market share? Did the CEO get fired? Are we in a recession? Is the company expanding its international reach?
The more you can understand the circumstances under which the stock price is lower or higher than before, the better you will be able to separate yourself from that original price.
Next, take a look at your own financial situation. Do you need the money soon? Are there financial goals in the next 1-3 years that depend on this money? What happens if the company goes bankrupt, the stock price goes to 0 and you lose your income, will you be able to recover? How much of your net worth is tied to this stock?
These questions will help you put your financial life back at the center of your decision and help you ignore the unpredictable market movements.
How to Handle RSUs: Overconfidence
What is Overconfidence
Overconfidence bias is our belief that we are above average at most things. Whether it’s driving skills or our ability to evaluate investments, overconfidence bias is particularly inflated when we have had recent success. When it comes to investing, overconfidence bias prevents us from evaluating risk intelligently.
How it plays out in RSUs
The price of your stock is on the up and up, it can’t be stopped, any news is good news, and you think you have the inside scoop as to why it just can’t stop. You’re confident that when your shares vest you are going to hold on to it because you know, in fact, you are certain, that it has plenty of upside. You work for the company after all and you know what is going to happen before the market does.
With your confidence comes outsized allocation to your company stock. You refuse to sell, you refuse to diversify, and you refuse to accept the reality of the risk you face.
How to fight it
Play the devil’s advocate with yourself. Write down a long list of all the things that could go wrong with the company, the industry it is in, and the market.
Then write down all the reasons why the company is going to continue to do well. However, split these reasons into two columns: facts and assumptions.
Finally, ask yourself what is the most I can lose before my financial future is derailed. If you have meager aspirations and are frugal, then maybe you can stand to lose a lot.
Use this number to evaluate how much you may want to sell now. If you must be overconfident, do so with the money that won’t negatively impact your life.
How to Handle RSUs: Regret Aversion
What is Regret Aversion
Regret Aversion prevents us from making decisions that we are worried we might regret later. In most cases, this makes us good upstanding citizens. However, when it comes to selling an investment we often try to avoid the feeling of regret if it goes up in value or FOMO.
How it plays out in RSUs
Regret aversion can show itself in both good performance and poor performance. If the stock is going up you may feel that you will regret selling if it keeps going up. With the stock going down, you might regret it as soon as you sell, if the stock price recovers.
The worst part about regret aversion and the price of your stock is that while your decision to sell happens at a specific point of time, your ability to evaluate the price of the stock lasts forever. You simply need to look at it at the “right” time and feel that you made the “wrong” decision.
How to fight it
The best way to fight your feeling of regret is to separate yourself from what is and what can be.
What is, is your current financial situation and your need for this money to do something for you. That need can be buying a home or simply avoiding the risk that your financial well-being is tied to compensation from the same company that your money is invested in.
What can be, is what can the stock be worth at any point in time. Believe it or not, this is completely irrelevant, because when that time comes, your financial needs may be completely different.
Don’t let the stock price dictate what kind of life you can and can’t live.
How to Handle RSUs: Endowment Effect
What is the Endowment Effect
With the endowment effect, we perceive something to be worth more simply because we already own it. This frequently happens with people that inherit investments or property from their deceased loved ones.
How it plays out in RSUs
You don’t even get a choice. You simply get paid out in your company stock and you become the proud owner. Outside of choosing to start your employment there you never had a choice to buy or not to buy.
The endowment effect is evident in the fact that for a lot of individuals their company ownership eclipses any of their investments. With this act of aggressive accumulation, they are saying their company is better than any other investment out there.
How to fight it
Just like other biases, to fight this one requires you to look inside. Ask yourself one simple question.
If you were to get the same amount of cash as the stock you currently have would you buy the same exact stock in the same exact amount?
If you still manage to answer this question with a yes, be sure to write down why this is the best investment in the world and be sure that you truly believe it.
What’s next
Without looking at your RSU decisions from the lens of emotions it is hard to understand how to handle your RSUs rationally. You become trapped. Forever looking at the price of the stock. Trying to anticipate what is truly unpredictable and trying to rationalize your inside point of view as you completely throw all personal financial goals out of the window.
However, that doesn’t have to be the case if you spend a little time trying to understand what you are feeling. Next time you start to think about what to do with your RSUs take out a notebook and go through each one of these biases. Ask yourself if you could be a victim to any of them and try to follow the exercises to overcome them.
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