Saturday, December 15, 2007

Free Money: ESPP

If your company is offering Employee Stock Purchase Plan (ESPP), then you have a money tree. It can give you an outrageous, guaranteed return rate.

ESPP is a plan where you pledge a percentage of your after-tax salary to be deducted every paycheck period during the plan's offering period ('offering' because you are offering your salary to the great company of yours).

At the end of the offering period, the collected money is used to buy the company's stocks at a discounted price. The discount rate is set in the plan and is applied to the lower stock price at the beginning and ending of the offering period. The exact stock pricing vary among plans; some use only the stock price at the end of the period.

My company's offerring period lasts for 3 months, and the lower stock price is purchased at a 5% discount. That means, if you sell it on the same day, it becomes a guaranteed rate of at least 5%. The exact return rate is calculated as thus:

Return rate
= profit/contribution
= (sale proceed - contribution) / contribution
= (purchased share * price per share - contribution) / contribution
= ((contribution / (price per share * (1 - discount rate))) * price per share) / contribution
= 1/(1 - discount rate) - 1

For me, it's 1/(1-.05) - 1 = 5.26%. Imagine that, my money grows 5.26% within 3 months! If you were to put the contribution in a savings account, you'd need to find one with an APY of 18.97% to get the same return rate!

So, let me just restate this amazing tidbit: 5% ESPP discount has the same return rate as a 18.97% APY savings account!

Look can really be deceiving. Without running the numbers, I wouldn't have figured out that the ho-hum, just so-so discount rate is actually an amazing 18.97% APY. Furthermore, had my company stopped being the cheap-ass they were and offered a 15% discount rate like many other companies, that would equal 71.22% APY with $500/month contribution.

I have a google spreadsheet that you can copy and start playing around with if you have a google account. To use it, simply replace the bolded fields with your numbers. The comparison is between putting $500/mo to the ESPP plan or letting it compound in a savings account. Unfortunately because I am not skilled in spreadsheet programming, you'd have to figure out the Savings Acount APR manually by trial-and-error: put in various figures until the difference is close to zero.

If you do not have a google account, you still can view it but not play with it.

The return rate calculated by the spreadsheet is actually the minimum guaranteed rate. If the the stock price is rising during the offering period, your return rate will be even higher to the point of being mind-boggling! If the stock price is dropping like a lead, you will still make the minimum guaranteed rate as long as your company is still traded.

But, but, surely, something this good must have a bunch of gotchas, right? Yes:

1. Some companies prevents this activity by putting a holding period: you have to wait for several days/weeks after the end of the offering period before you are allowed to sell the stocks.

This introduces risk. If the stock price drops before the holding period is over, you have to choose whether to keep the stocks or sell them at a loss. If you want to keep the stock, be mindful not to keep too many eggs in one basket because your income is already a big and significant egg in that basket (your job is an investment too!).

2. The reason some companies prevent this is because the spirit of ESPP is to help employees become owners. For me, this present an ethical dilemma, but I believe that I am not doing the company or any other employees any significant harm. Furthermore, if the company really wants to emphasize the ownership benefit, it can enforce a holding period. In the meantime, it is really a very low-hanging fruit that I simply has to take advantage of.

Anyway, don't be shy to share your numbers.

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