Employee Stock Purchase Plan (ESPP) Is A Fantastic Deal

If you work for a publicly traded company which offers an Employee Stock Purchase Plan (ESPP), you’ve got yourself a fantastic deal. An ESPP typically works this way:

  1. You contribute to the ESPP from 1% to 10% of your salary. The contribution is taken out from your paycheck. This is calculated on pre-tax salary but taken after tax (unlike 401k, no tax deduction on ESPP contributions).
  2. At the end of a “purchase period,” usually every 6 months, the employer will purchase company stock for you using your contributions during the purchase period. You get a 15% discount on the purchase price. The employer takes the price of the company stock at the beginning of the purchase period and the price at the end of the purchase period, whichever is lower, and THEN gives you a 15% discount from that price.
  3. You can sell the purchased stock right away or hold on to them longer for preferential tax treatment.

Your plan may work a little differently. Check with your employer for details.

The 15% discount is a big deal. It turns out to be a 90% annualized return or higher.

How so? Suppose the stock was $22 at the beginning of the purchase period and it went down to $20 at the end of the period 6 months later. Here’s what happens:

  1. Because the stock went down, your purchase price will be 15% discount to the price at the end of the purchase period, which is $20 * 85% = $17/share.
  2. Suppose you contributed $255 per paycheck twice a month. Over a 6-month period you contributed $255 * 12 = $3,060.
  3. You will receive $3,060 / $17 = 180 shares. You sell 180 shares at $20/share and receive $20 * 180 = $3,600, earning a profit of $3,600 – $3,060 = $540.

Percentage-wise your return is $540 / $3,060 = 17.65%. But, because your $3,060 was contributed over a 6-month period, the first contribution was tied up for 6 months, and the last contribution was tied up for only a few days. On average your money is only tied up for 3 months. So, earning 17.65% risk free for tying up your money for 3 months is equivalent to earning (1 + 17.65%) ^ 4 – 1 = 91.6% a year.

90%+ a year return is fantastic, isn’t it? That’s when the employer’s stock went down. Had the stock gone up from $20 at the beginning of the purchase period to $22 at the end, your return will be even higher at 180%!

[Update on May 30, 2008]: I created an online spreadsheet on Zoho. You can plug in your own numbers and calculate the annualized return. The annualized return is what a savings account will have to offer in order to match the same return from an ESPP. Even at 5% discount without lookback, an ESPP is still equivalent to a 20% APY savings account.

What should you do if your employer offers an ESPP? Participate to the MAXIMUM allowed as long as you can sell the stock soon after the stock is purchased.

Should you hold the purchased stock longer for preferential tax treatment? No! On the typical 6-month purchase program, you will have to hold on to the stock for additional 18 months in order to get preferential tax treatment. If everything goes well, you can reduce the tax on your profit from say 35% to 15%. In the above example, that will save you $540 * 20% = $108. But if your employer’s stock goes down 3% during the 18 months you are holding the stock, because your entire $3,600 is at stake, the tax benefit will be completely wiped out. You already earned 90% annualized return on the purchase. Holding on for another 18 months and hoping the stock won’t go down 3% is really penny wise pound foolish.

More technical details about ESPP on the web:

See All Your Accounts In One Place

Track your net worth, asset allocation, and portfolio performance with free financial tools from Personal Capital.

FREE E-mail Newsletter

Join over 3,000 readers and get new articles by e-mail:

No spam. Unsubscribe any time.

Comments

  1. Flexo says

    Timely article. My company just began offering ESPP. The purchase period is three months, so there are 4 purchases each year, at a 15% discount of the price at either the beginning or end of the quarter. Our stock price is at the highest its ever been (IPO was in late 2001), but no matter what happens, it’s an automatic 15% increase each quarter. I’ll be investing the maximum 10% of my salary, and ofsetting the missing cash flow with savings each quarter. We can sell immediately, but I’m a designated employee, so I may have to way to until an open trading window is declared.

    I’ve written about it on my blog

  2. Adam says

    This is an outstanding post. It’s so good that I’ve quoted you liberally in a post on the same topic on my blog:

    Psychohistory

    I’m definitely going to subscribe to your feed.

    One minor nit. Your analysis on the “3 month average” is not quite right. You should do a discounted cash flow on the paycheck contributions, and then calculate the internal rate of return on the investment over the 6 months. When I did this (see my blog post), I got a 98.4% return, making the assumption that he got paid every 2 weeks.

    Thanks for the great post! Loved it.
    Adam

  3. TFB says

    Thank you Adam for the compliments. With regard to the exact return, I didn’t want to get too technical. After you understand the return is over 90%, it makes very little difference whether it’s 91% or 98%. If you really want to be exact, you also have to take into account the 3-business-day settlement period and a typical $20 commission on the sale. For more fun with math, check out this post:

    TIPS Pricing Is Complex

  4. ricemutt says

    Nice article. I wrote one a few months back on this exact topic, and it’s interesting to see we have the same advice/approach. I’ve talked to many friends who don’t seel until they can get preferential tax treatment, or do nothing with ESPP shares in their account at all.

    In my own personal experience, the companies who’ve offered ESPP have had big downside risks to maintaining their share price over 18 months’ time. They’re in some trouble, or they’re high-growth stocks whose prices are fairly volatile, and all have been tech companies. Holding might work out sometimes, but to me, it’s better to have the “free” money than risk it another 18 months or so.

  5. espp_in_cincy says

    I have a question regarding ESPPs. The 15% discount, is that a form of reportable income or do you just get that margin for free? I read an article on compensation income and disqualifying dispositions and it is still unclear to me.

  6. TFB says

    The discount is reportable income. Your employer will track it and add it to your W-2 if you sell right away. Read the Fairmark link for more details.

  7. Anonymous says

    We disagree with your analysis.

    Your money is tied up for an average of 3 months (which is correct) – but you do not have the opportunity to purchase shares every 3 months – only twice per year.

    Also, you need to consider the opportunity cost of not investing the money at a risk-free rate alternatively.

    Shouldn’t the calculation of return on an annual basis really be 1 + 17.65% ^2, ~ 38.4% before factoring opportunity cost and before factoring tax effects.

    I think you are overstating returns in your analysis above. That being said, ESPP’s are still great deals.

  8. TFB says

    The math is correct. You get this opportunity to earn 17.65% in exchange for tying up your money for 3 months. Even if you only get this opportunity once a year, the annualized return on the opportunity itself is still ~90%. The fact that you get to do this twice a year only means you get to earn ~90% annualized on more dollars. Adam in comment #2 said it should’ve been even higher at 98%. I made a spreadsheet for bi-monthly payrolls and I also added a $20 commission for the sale and 3 business days settlement delay. It came out to 87% annualized when everything is taken into consideration. You can look at the spreadsheet if you are interested.

    ~90% annualized versus risk free return of 5-6%, both taxable, I’d take the former any day. I wish I could do this on 100% of my salary.

  9. Anonymous says

    Great article, very useful. I just started with a new company and learned about their ESPP. Instead of a 6 month purchase period, however, I’ve been told the stocks are bought monthly and contributions are met by the employer on a monthly basis by 25%. In this case, when would be the best time to sell?

    Thanks!

  10. Anonymous says

    This math in this article is crap. ESPPs are excellent, but not for the reason quoted in the article. The 90% annualized return is ficticious and over-hyped (its even bolded and colored red to draw attention). It seems to be intentionally misleading (or even worse, unintentionally misleading). You may think quoting an annualized return is useful, but it is absolutely incorrect to apply it in this context. Using XIRR() and quoting the 90% return is reckless and dangerous to your readers.

    The fact is you get a 17.65% return after 6 months of investing. You can’t arbitrarily say your money was tied up for 3 months on average and then annualize the 6 month figure by raising it to the 4th power! Furthermore, there is no compounding effect from ESPPs, you recontribute the next 6 months. At least use your math within the framework of the ESPP. The reality is that you get 17% return on half your dollars after 6 months, and then 17% return on a different half of your dollars, 6 months later. This equates to a 17% annual return.

    Imagine a 12-month CD with return of 5%. You can’t say that on average the money was tied up for 6 months, and then use the year end 5% return to calculate an annualized return from the 6 month point! This would be like saying 1.05^2 is your annualized return .. but we already know the real annual return is 5%!

    To further prove my over-hyped point, assume a single payment of -$255 on 1/15/2007 that you can immediately flip on 1/18/2007 for $280 (with $17 cost, $20 sale, and $20 commission like your example). Using Excel’s XIRR() on that produces an annualized return of 8746485%! Amazing right? Well not really .. it doesn’t mean anything! I suppose it would be more credible if I colored it red and bolded it.

  11. TFB says

    Time and the rate of return are related. If it takes 1 year to earn 5%, it’s 5% rate of return per year. If it takes 10 years to earn 5%, the return is a lot less. Same with time frames shorter than 1 year. If it takes 3 months to earn 17.65%, the rate of return is a lot higher than what you’d earn if it takes one full year to earn 17.65%. With your CD example, if the CD allows you to deposit $100 a month and then gives you $1,260 at the end of the year, the return is a lot higher than a CD which asks for $1,200 up front and gives you the same at the end of the year.

  12. Anonymous says

    I wonder if you can give an opinion on some tangled up issues with my ESPP. (I have totally screwed up by treating these shares as regular stock.) I’ve been transferring shares for several years into my son’s ugma account (using gift-splitting with my spouse in some cases). I’ve only now realized that I need to declare income on the 15% discount for qualifying dispositions. Do I also need to declare a long-term capital gain at the time of gift? I thought the stepped up cost basis (original cost plus declared ordinary income) would be passed along to him as with typical gifts of stock. Thanks in advance for you help. I enjoy reading your blog.

  13. TFB says

    Fairmark has very good writeup on the tax treatment of ESPP dispositions. Please note the two links in the end of that article with more detailed info on both qualified and non-qualified dispositions.

    Their book Consider Your Options covers both stock options and ESPP. It is an excellent resource.

  14. Anonymous says

    Thanks. I actually had some communication with Kaye Thomas about my issue. Her site is a great resource; I think I will buy the book.

  15. Peter Answers says

    It takes about a week for the shares to actually hit my account, and that week where your shares have been bought but you can’t sell them define your risk window. I eliminate this risk by shorting the shares right away and then covering when the shares hit my account. It is lock solid, no risk, guarenteed return. As long as you are allowed to sell your shares right away, you are a moron for not taking out the absolute maximum you can. If you cant afford the money taken out of your check, borrow it.

  16. Miguel says

    TFB – great article – I encourage my friends to take advantage of ESPP for just these reasons, even though our company has just changed things up a bit recently. We get a 15% discount off the period-end price only, no looking back to the start price anymore. That said, I’ve seen share prices fluctuate (ok, drop) dramatically just after the ESPP buy date, perhaps caused or aided by a flood of selling immediately after all my colleagues and I take control of new shares. I remember reading somewhere that companies with ESPP plans are supposed to buffer this effect somehow. Do you know anything about that?

  17. TFB says

    Miguel – No I don’t know anything about companies buffering the effect of employees selling shares acquired from ESPP. Depending on the trading volume of the company’s stock, what employees sell can be a very small percentage of the overall volume even if all employees sell right away.

  18. Deb says

    hmmmm, the advice to sell immediately has been followed religiously by a number of my co-workers, in this case to their detriment.

    I suppose if your company doesn’t meet the basic Buy & Hold investment criteria because it’s not a great company with great management, fear or a decline in price would dictate selling immediately. However, if your company is worthy of a long term investment decision (other than the guaranteed short-term payoff offered by immediate ESSP share disposition), consider the following:

    In the 10 years I’ve been employed in the rock-solid no-debt firm which employs me, I have participated in our ESPP to the 15% max. The average price for the first 3 years was below $10. For the next few years, it averaged around $35, then underwent a 2:1 split. Over then last few years the share price has quadrupled again. Sure, during the decline there were days/weeks/months that some shares were under water for a while, but since I viewed it as a long term opportunity, I wasn’t worried. Buy & Hold. So shares that I purchased for $10 that my friends sold 7 years ago for $11.50 out of fear that the price would go down would be worth about $140 each now.

    My advice: Don’t treat ESPP any different than any other investment. Stay in if it makes sense, get out ASAP if it doesn’t.

  19. choppy says

    Hi TFB,

    I’d love to see a refresh of this blog post.

    A lot of changes I see:
    1) discount lowered from 15 to 10%
    2) offering price is no longer the lower of the beginning or ending offering period price
    3) new tax laws on short term vs long term capital gains tax
    4) markets are volatile and declining…think HP! ouch!

    Yet my savings account still can’t muster anything beyond 1%! so any tips/strategies for optimizing ESPP in 2010 and beyond would be greatly appreciated.

  20. Dru says

    Question…I have signed up for the maximum of 474 shares @ $18.00/share with my company. We are now trading at approx $28.00/share. I opted for a lump sum payment instead of payroll deduction. I can pay for the 474 shares on the 1st or 15th of the month, then sell at $28.00 (or whatever it is trading) about 3 days later.

    I am netting approx $10.00/share, so am I paying taxes on the difference? Would this mean that if the above scenario were done, I would be crazy not to do it? It looks like that if you even had to borrow the money for a 10 day period, it would be worth it (unless the stock totally crashed)

    Am I right.

    Thanks in advance for the replies.

  21. TFB says

    Dru – You are right. It would be crazy not to do it in the scenario you described. Yes you pay taxes but you still get to keep a big portion of it after taxes.

  22. Ed says

    My company is offering ESPP starting 1/1/2011. Like some of the other comments, I have issue with the effective annualized return rate. I do agree the annualized return on part of the investment is ~91%, but the investment does not compound. Consider the following:

    Total amount invested in six month period: $10,000.00
    Shares sold with no change in stock price: $11,764.71 (1/0.85 gain)
    Net six month gain $ 1,764.71

    Repeat for next six month period — total gain = $3,529.42 = (2 * $1,764.71)

    Average daily amount invested for year: $5,000.00
    Percent gain for 1-year: $3529.42 / $5000.00 = 70.59%

    NOTE: 70.59% = 4 * 17.65% (within rounding error)

    Am I missing something?

    Thanks for any comments.

  23. TFB says

    Ed – See comment #11. Getting paid $ 1,764.71 every six months is different from getting paid $3,529.42 every twelve months. Anyway, whether it’s 71% or 91%, it’s still a fantastic deal, isn’t it?

  24. ajdj says

    too good to be true – you get 15% real return (after inflation) but not more

    the problem with TFB’s logic is he/she is confusing average investment (or money tied up as it is called in the article) with the initial investment required in this case. In some cases you can use that as a proxy for example if you have a broker account and you put in money on 15th of the month then at the end of month your return can be calculatd this way by treating the investment as being half (or the holding as being half month which should give similar results). However in this case the initial investment is not half of your eventual purchase amount unless you think your future salary is worth nothing in today’s dollar. (most of us think $1000 I am getting in two weeks is pretty close to $1000 I have today). so what is your initial investment then? it is your each paycheck deduction for ESPP discounted to the grant date – this is your committed investment on day 0 (you can get technical that you can still get out of ESPP before purchase but you can’t get the return either in that case). Unless you future salary is worthless to you you probably won’t get 90% or 70% return in this case. Given today’s low discount rate your initial investment will be very close to your purchase amount in 6 month if you use the short rate as your discount rate (you can argue to use a more subjective discount rate e.g. your personal consumption discount rate) The confusion comes from how you defined the money invested and how you treat investment committed in the future in this case. if you carry a balance on credit card or have mortgage you should know this – future obligation is still obligation so is future investment. so if you use inflation rate as your discount rate to calculate your initial investment, then ESPP is naturally hedged against inflation – meaning you get a 15% real return after inflation assuming you sell it right away. no work for 15% real return – still a very good deal. By the same logic you don’t get the return compounded or added, because your second purchase is on different future earnings. (the anonymous post on 12/26/2007 has the right intuition but did not state the logic correctly). why don’t all the people do this? you should do this if you can afford it or if you can borrow at a rate lower than 15% – so if you have to run up your credit card balance to do it then it is probably not worth it, but you can use your 5% mortgage loan to finance it.

  25. Grace says

    Right now my company has a 6-month purchase period where I sell immediately after the period is over. My company is moving to a 24-month discounted purchase lock-in with up to 4 purchase periods. I’m not sure what my strategy should be with this new plan. Please advise. Thanks!

  26. TFB says

    @Grace – Can you elaborate on what it means by “a 24-month discounted purchase lock-in with up to 4 purchase periods”? Say a purchase period starts on Jan. 1, 2012. You buy on what date? July 1, 2012? At what price, and then what? When can you sell, Jan. 1, 2014? What about the second purchase period? Also mandatory hold until Jan. 1, 2014?

  27. bucky says

    @Anonymous on December 26, 2007
    “The 90% annualized return is ficticious and over-hyped”

    I know this was an old comment, but I just read this blog. The 90% may be overhyped, but it’s certainly not fictitious. What it means is that if you put the amount you set aside for ESPP in a savings account, that savings account would have to give you a 90% annual interest rate to match it.

    “To further prove my over-hyped point, assume a single payment of -$255 on 1/15/2007 that you can immediately flip on 1/18/2007 for $280 (with $17 cost, $20 sale, and $20 commission like your example). Using Excel’s XIRR() on that produces an annualized return of 8746485%! Amazing right? Well not really .. it doesn’t mean anything!”

    It does mean something. It means that you should definitely flip that $255 into $280 before investing into your eventual investment.

    Do this exercise, if you saved 10% of your monthly salary into a bank account that gave 17.6% interest rate, how much would you have at the end of the year? Compare that if you had put the 10% into an ESPP.

  28. Grace says

    Elaboration on “a 24-month discounted purchase lock-in with up to 4 purchase periods” (comment #27)…
    * Enrollment in the August 1, 2011 Offering Period will allow participants to lock-in a purchase price based upon 85% of Company’s closing stock price on August 1, 2011, for up to four (4) purchase periods.
    * ESPP participants will purchase shares every 6 months at 85% of the lower of the closing stock price on either August 1, 2011 or on the Purchase Date.
    * The Offering Periods under the ESPP will overlap; that is, new Offering Periods
    will begin under the ESPP while other Offering Periods are already underway.
    Participants may lock-in a share purchase price at the beginning of the Offering Period in which they become enrolled.
    * The ESPP has an auto-reset feature that automatically resets to a new 24 month Offering Period if the stock price at the start of any new Offering Period is lower than it was at the beginning of the Offering Period in which the participant is enrolled.

    I don’t think there is a mandatory hold. If I understand this new plan correctly, I should still sell immediately after each 6-month period, right?

  29. A Different Mark says

    @ bucky on July 27, 2011
    The 90% Annualized Return (IRR) is a meaningless numerical trick. What we’re really interested in is what sort of interest rate you’d have to get (probably called ROI) from a bank to equal the benefits of ESPP.

    If you put $1000 into ESPP over a six-month period, in equal payments, we all agree that you get $1176.50 back at the end. Suppose you do that again for the second half of a year: you put out another $1000 and get back another $1176.50. You end up with $2353.00.

    Now, suppose that, instead of contributing to the ESPP, you put the money (again, as equal biweekly payments) into a bank offering a 35.3% annual interest rate. Your ending principal would be $2000; your average balance over the year would be $1000 (let’s ignore compounding, though it helps my point). $1000 at 35.3% gives a $353.00 credit, so your ending balance would be $2353.00 — the same as the ESPP. This proves that the *meaningful* annual return is 35.3%, not 90%.

  30. Bucky says

    @A Different Mark:

    I completely get what you’re saying. But you are mis-applying what “annualized return” means. Annualized return is the same as APY (annual percentage yield), which is a standard calculation that banks use for savings accounts and CDs. I don’t hear anyone claiming that APY is a meaningless numerical trick. Let me give a few examples to make my point:

    1. Let’s compare your examples over a 10 year period. If you put in $1000 into ESPP every 6 months over 10 years, you would end up with $23530. That’s an absolute gain of $3530, which is a total percentage gain of 17.65%, which comes out to an annualized return of 1.64%. According to your logic, would you would be better off putting your money into a bank account with 2% annual interest rate rather than ESPP?

    2. Which would get you more return:
    A. Jan-Jun: put $1000 in bank at 35.3%. July-Dec: Put $2000 in bank at 35.5%
    B. Jan-Jun: put $1000 in ESPP. July-Dec: Put $1000 in ESPP, $1000 in bank at 35.5%
    The answer is to simply compare the APY. That’s the purpose of APY.

    People seem to get stuck on the fact that ESPP is only a 6-month period, therefore annualized return/APY is meaningless/fictitious. Look, the whole point of APY is to normalize the return over a common period. It doesn’t matter what the length of the period it. If you get stuck on this, simply re-do all your calculations for a monthly-percentage-yield or 6-month-percentage-yield. The bottom line is that for a 6-month period, the only way you can beat ESPP is to find an investment that can give you > 90% APY.

  31. xswalden1 says

    The comments remind me of the government regulation on payday loans. When they looked at APY for loans, when including fees, etc. The APY was 250-1000%. Just as the prior comment correctly state that the standard calculation terminology is APY. The below link maybe an interesting read for some.

    http://www.in.gov/dfi/2366.htm

  32. Myster says

    My company matches with 15% at the end of the quarter (the quarter where I purchase the shares) and another 5% at the end of the year if I don’t sell the stock. Do you think it’s worth holding for the entire year?

  33. Kris says

    Just a couple questions , (my employer offers the ESPP but no discounts are given) I have weekly deductions come from my paycheck to purchase shares usually by the next business day , however lately it seems as though my employer is not immediately investing the funds , but suspending them in a pending state ? Some years ago my Employer took over the ESPP and removed Merrill Lynch , what I wanted to know was ,
    1) How is an employer able to legally maintain operation of an ESPP on a large scale without violating ethics with respect to obviously knowing what contributions will be made on what day and time pertaining to t
    heir Stock ?
    2)Would there be any time limit that a company would be obligated to invest the funds that have been transferred , or could they just wait an sit on it (collecting interest, or invest it themselves in a separate account while it only displays “Pending” to the owners until they’ve made a few bucks and return it or should I say invest it but at a higher rate than it could’ve been , thereby gaining two fold ?
    3) Is there any authority they must present how investing takes place ?

  34. Harry says

    Kris – If there are no discounts given, there doesn’t appear to be a reason to participate. After all you can buy however many shares you want on your own whenever you want (blackout policy notwithstanding). I don’t know the answer to your questions. They are best addressed to the stock admin department at your employer as to when the shares will actually be purchased and handed over to you.

  35. sam says

    I know this article is old. But, the math in it is horribly wrong. The annual return rate is not 90%+, it’s more like 4% annual effective on a net basis (NOT 90%). I’ll show you why below.
    Suppose you earn $80k/yr. You can contribute 10% of your salary per year or $8k/yr. For simplicity, suppose you invest every pay period and there are 24 pay periods. You invest $8k/24 = $333.33 every ~15 days. The price of the underlying stock for which you get a 15% discount doesn’t really matter (what will matter later is its volatility). And, assuming you sell it immediately the reference stock price is $60 per share. This means you buy it at $60 * .85 = $51 per share. Since, every quarter you invested $333.33 * 6 = $2000, you buy $2000 / $51 = 39 shares (you can’t buy fractions of shares). You sell them right away at $60. You get $2340. You’d say to yourself, I invested $2000 and got $2340 back plus I have $12.94 uninvested. So, I made almost 18% return! But, then again, you’d be wrong. Lets get to the details: When you sell, you incur commission cost, usually around $20. Also, you trigger taxs (the 15% discount is taxed as ordinary income, and the gains are taxed at short term capital gains tax rate which can be higher than ordinary income depending on the state you live in), we’ll assume you pay these taxes quarterly too (as the law requires). And, we’ll factor in the time value of money ($1 now is worth more $1 in 1 year).
    Over the course of 1 year, you’d run through this series of cash flows at ~15 day intervals:
    intervals 1 – 5: -$333.33
    interval 6: -$333.33 + $2340 (stock sale) + $12.94 (uninvested cash) – $20 (commission) – $118 (fed tax and ny state short term capital gains tax) = $1881
    lets explain the tax bill of 118. You get taxed gains ($2340 – $2000 – $20) * (.25 + .09) = $118. The 25% is federal and 9% is about the NYC tax on capital gains (varies by state).
    repeat these 6 intervals identically four times (remember, stock price doesn’t matter much)
    The internal rate of return of this cashflow is just over 4%. A far cry from the claimed 90% annual return.
    Note, this also assumed that the stock price doesn’t fall before you can sell it. If it does, two things fall, you’re gross returns and the taxable portion. But, the net return is squeezed nonetheless. Buy and sell or buy and hold with caution. And, don’t lie to yourself thinking you are gaining 90% returns.

  36. Harry says

    Sam – I don’t know how you did your math. Putting your cash flow series in a spreadsheet with XIRR, I get 160%. It’s higher than the 90% because you are assuming selling every quarter instead of every six months.

    1/15/2013 -333.33
    1/31/2013 -333.33
    2/15/2013 -333.33
    2/28/2013 -333.33
    3/15/2013 -333.33
    3/31/2013 1881
    4/15/2013 -333.33
    4/30/2013 -333.33
    5/15/2013 -333.33
    5/31/2013 -333.33
    6/15/2013 -333.33
    6/30/2013 1881
    7/15/2013 -333.33
    7/31/2013 -333.33
    8/15/2013 -333.33
    8/31/2013 -333.33
    9/15/2013 -333.33
    9/30/2013 1881
    10/15/2013 -333.33
    10/31/2013 -333.33
    11/15/2013 -333.33
    11/30/2013 -333.33
    12/15/2013 -333.33
    12/31/2013 1881

    XIRR(B1:B24,A1:A24) = 160%

    That’s how much a bank savings account would have to pay after taxes in order to deliver the same cash flow.

  37. sam says

    Great job Harry! I didn’t use a finance calculator and just plugged it into excel and used the irr function assuming it assumed all inputs were evenly spaced within one year. As it turns out, it assumes that all inputs are one year apart! So, the above calculation of 4% assumes a stupid 24 year cash flow cycle, hahahaha! When I annualized the IRR result (1+4%)^24 – 1 = 160%. You’re right!
    I verified xirr gives the same result with date input. Thanks for teaching me man!

  38. sam says

    Harry, I want you to look through this. Using the same assumptions as before except that the taxable portion should really be only $113 (the un-invested amount shouldn’t be taxed). So, with this modification, the annual IRR is 166%. Ok, does that seem meaningful? That is, we fixed a calculation error with net impact of $20 a year and the IRR shoots up 6%. What is the marginal utility of $5 per quarter for a person earning $80k/yr?
    This person invests $8k/yr and gets back $8,877.32 net of taxes and fees. Layman return of 11% over the year. Compare that to the 166% IRR the cash flow analysis gives. Why I think using the layman return rate is more useful in this case is volume. If I find a penny on the floor, my annualized return rate is freakin’ positive infinity. If I put in 25 cents in a slot machine and get two quarters back, my annualized return is more than 205427259098698000000.0% (but excel can’t handle the actual calculation, the number is too big for excel). So, my point is that volume is too small to boost 160% or even 90% returns, though, they technically be true. You can see that $877 extra net dollars spread out over 1 year isn’t bad, I’ll take it any day, but it’s not going to significantly affect this persons quality of life.
    So, for practical purposes, I’d say ESPP is a good deal that practically gives you at a 1% annual pay raise.

  39. Harry says

    Sam – I agree it’s not going to make you rich because of the limit on how much you can put in. However, the high IRR shows it’s a great deal that everyone should contribute to the maximum allowed and that selling right away is already good enough. Those are the two points I tried to drive home.

  40. Kevin Timothy says

    Author,

    Thank you much as this is a very well written piece of
    information. I just became eligible and I have never had
    any experience with using ESSP. This article made things
    crystal clear. My main concern was when I can actually
    “purchase” the stock. I wasn’t aware that there is a period,
    and that it varies from company to company.

  41. Steve says

    What if you can’t sell the stock right away? I work at a company with an ESPP, but you’re required to hold the stock for 6 months before you can sell it. The annualized return would be to 30% or less – and that’s if you assume the calculation still applies, since there’s far more risk involved.

    • Aaron says

      Steve:

      That’s simple. Short an equivalent amount of the stock when you get your ESPP shares. Then, at the end of 6 months, use the acquired shares to cover your short position.

    • Steve says

      Thanks for the response. Shorting employer stock is against company policy. However, as far as I can tell trading in options is allowed. Often (I don’t know how often) companies that prohibit shorting company stock, also prohibit effectively shorting company stock via options.

  42. Harry says

    It isn’t as clear-cut but I would still participate. It’s possible to lose money in one cycle but chances are it will be made up in other cycles. Investing in a diversified portfolio can lose money in six months too. After all, only a small amount of money is being held at any point.

Leave a Reply

Your email address will not be published. Required fields are marked *