For years I’ve jokingly stated the number one investment rule is to:
Never invest in a company that would hire you or one of your friends.
Although this gets a laugh, there is some truth to this advice. Employees of a company are typically only told one side of the financial story. News about every deal or sale is shared throughout the company. However, news about the costs associated with getting those sales are buried. The real bad news is kept hidden to keep morale up. This puts the average employee into the position of thinking they have an inside track on how well their company is doing compared to the typical investor.
This leads to problems when that employee takes part of their paycheck, either directly or in a 401K, and invests in their own company. What happens when the company hits hard times? Not only can you lose your job, but you end up losing a portion of your retirement. You lose twice.
If you truly had inside information that your company should be valued higher then trading on that information is illegal. That kind of investment can land you in jail. But that is not what this post is about. This post is about hedging your financial streams from your employer.
Job losses and falling stock value often go hand in hand. If you look in the news you will see the companies with the most layoffs are the ones with huge drops in their stock price. You can sit around waiting for your unemployment benefits to kick in or you can build yourself a sweet parachute.
I now think the best way to protect yourself as an employee is to buy long-term puts (LEAPS) on your own company. In the event management doesn’t drive your company off the cliff, the puts will expire worthless. So you would only buy a small amount of protection each year. Maybe $500. If your company does tank and you lose your job, the stock price will most likely fall and your options will become extremely valuable.
I’m going to set up an example with a few employees following different strategies.
- Earl Enron – Uses savings and his company 401K to invest in his company. Company goes under. Earl loses both his job and his retirement.
- Amy Apple – Buys puts against her company. Company does very well. Puts expire worthless. Amy gets a raise and a bonus in excess of the amount she lost on the puts.
- Willy Wamu – Buys puts against his company. Company does awful. Willy gets laid off. Stock goes into free fall. Willy’s puts become very valuable. Instead of looking for a job right away, Willy takes his family on a month vacation.
One last point. If you buy puts against your own company, don’t tell anyone. Your co-workers might think you are out to sabotage the company. In the event you do screw something up as an employee and bring down the company, having a paper trail leading back to the fact you profited from the event won’t be good. Maybe the puts should be held in an account of a spouse or parent?
Perhaps a more politically correct option is to just short the sector that you work in. The logic here is that whatever downturn hits your company will hit other related companies. In the above example Willy Wamu could short the BIX (S&P Banking Index). Then if the banking sector as a whole goes down he would have still made money, just not as much.
UPDATE: Part 2