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

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.

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%.

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?

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.

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.