For the average employee with little to no experience in investing in the stock market, being sold the benefits of joining a workplace share scheme might be the worst investment decision for them.
There are two share schemes approved by the UK tax office, HMRC, that are commonly offered or rather sold to employees in the UK. The first is Save As You Earn (SAYE) or sometimes known as Sharesave. The second is Share Incentive Plans (SIPs) or sometimes known as Share Match schemes.
Even though I have been investing in the stock market for many years now, when my employer offered their Sharesave scheme, I somehow threw all my investing principles out of the window and bought into all the upsides they told me, without stopping to think about all the downsides. Now I have been through those schemes, I want to share what I have learned with you.
For those of you not familiar with SAYE schemes, it is a savings plan that lasts for either 3 or 5 years, where at maturity, you are given the option to buy shares in your employer at the pre-agreed price, up to 20% discounted. During this time, you commit having a fixed amount of your net pay put away into a trust account.
So, if the shares were initially valued at 100p (i,e £1.00), then you could be offered the option to buy them in 3 years’ time at 80p. You commit to save a fixed amount, let’s say £50 a month. In 3 years, you would have saved £1800, which can buy you 2,250 shares at 80p each. If the price never changed in 3 years, those 2,250 shares would be worth £2,250, and you just made £450, or 25% return on investment, which is pretty good returns for 3 years.
Even though “prices of shares can go up as well as down, numbers are for illustration purposes only,” etc. The scheme has built-in safety nets, for if the price went up, then all is good. If the price went down, the employee can decide not to exercise the option to buy and simply take their £1800 back, no questions asked. All they would have lost is the opportunity cost and depreciation, which is a small risk to take for the potential growth.
The problem starts when you decide to keep hold of those shares rather than cashing them in for a quick profit. After all, one purpose of the scheme is to encourage share ownership and a sense of belonging. So why is it a problem to keep hold of the shares? Diversification is the problem or the lack of is.
My first rule of long term investment is diversification.
Share ownership always comes with an amount of risk. There’s always a chance the prices would drop off a cliff. Normally, an investor would spread the risk by diversifying their portfolio, but if the only thing in your portfolio is the shares of your employer, then you are exposed to far more risk than any sensible investor would take on.
Most people who dabble in the stock market usually start being confident in their ability to predict the market but end up making all the mistakes all amateurs make. We panic, we sell at the wrong time and get back in at the wrong time. Which isn’t a huge problem if this is just one out of a hundred different shares in your portfolio. However, if you are inexperienced, and this is the only share in your portfolio, then you are at the complete mercy of the market. Sure you could just sit on those shares forever, but that in itself can be expensive in opportunity costs.
Another type of incentive the UK government has approved is the Share Incentive Plans (SIPs), or Share Match scheme. The simplest way to describe this is it is a Buy One Get One Free offer, using pre-tax money no less. (Actually, HMRC allows the employer to do a Buy One Get Two Free offer.)
Usually, the bonus shares come with a condition that you have held on to your initial shares for a period of time. My employer offered us 1 extra share for each one we bought and kept for 3 years.
The benefits of this scheme are easy to see, you save on tax, and you get extra bonus shares. A basic rate taxpayer would save 20% in tax plus national insurance, and you get an extra one as bonus, effectively making a 100p share costing less than 40p of take-home pay.
One caveat is you must keep the shares for 5 years to avoid having to pay back the tax and national insurance.
That’s where the problem lies, a lot can happen to share prices in a few years. You are exposing yourself to the risk of holding the shares for several years, which again isn’t a problem if you have a diversified portfolio, but a big risk if you only hold one, or just a few different shares.
Employees are often encouraged to join these share schemes, as they can be a great way to save, and to buy into the company you work for. The sales literature would list all the benefits, which are genuine, but they don’t try to tell you how to reduce the risks associated with share ownership, you are left on your own on that.
I know people who have bought shares under the Share Match scheme at 300p, only to see the price crash to less than 100p, leaving them at a loss even with the tax savings and the bonus shares. They feel they have no choice but to hold on to the shares in the hope the price would recover. All the while, they are missing out the opportunity of having that money invested in an index fund that might give them 7% return per year.
It’s often argued that for an employee to join their workplace share purchasing scheme, is to take on higher risk that for an outsider investor. You are putting all your eggs in one basket. Not only are you tying your entire fortune to the performance of the company. In the worst-case scenario, you could lose your job only to find the shares worthless too.
So should you still join that SAYE scheme?
If it’s part of a well balanced and diversified portfolio, then it’s worth considering, especially if you believe in the company. If it’s your only investment, then I suggest you use it purely as a savings plan and don’t try to hold on to the shares as a high-risk investment.
Should you join a workplace Share Match scheme? Again, only as part of a well-balanced and diversified portfolio. If you are new to investing in the stock market, then I would say don’t do it, it’s more risk than it’s worth. Put your money into an index fund instead if you are new to investing, it’s much safer, and if you do it with an ISA account, then you shelter the growth from the taxman too.
Disclaimer: this article is purely based on opinion and should not be treated as financial advice.
The government’s information page on the share purchasing schemes can be found at https://www.gov.uk/tax-employee-share-schemes