#25 - Q&A US Monetary Policy, Competing Goals, Job Loss, RSUs and NQSOs

Q&A Day!
Q1: Easy Money & The Permanent Portfolio: we discuss what’s going on with US interest rates, what quantitative easing is and it’s effect of the economy. Then we talk about the permanent portfolio and how to asset-liability match. Be sure to check out the example of the young couple with 3 different goals (and different time frames!)

Q2: Couple with (Expensive)Competing Goals: be a team! Learn more about each other as a couple to achieve great things! Name your family. See the world from your partner’s eyes.

Q3: Dealing with a Job Loss: In this question, we discuss how important having a good emergency fund is, in case of job loss.

Q4: Employee Stock Options (specifically: RSUs and NQSOs): this question goes through the nitty gritty details of restricted stock versus non-qualified stock options. The tl/dr: RSUs are like cash, NQSOs are an option to potentially make some cash. RSUs you have to choice when you pay your taxes, NQSOs you do.

Submit your questions @MorgenRochard or @money_owners or https://www.moneyowners.com/askmorgen

Full transcript here:

Morgen Rochard:
You're listening to episode 25 of the Money Owners podcast with me, Morgen Rochard. Money Owners is a podcast for people who want to be mentally and financially crushing it. This podcast does not provide investment advice and nothing in this podcast should be misconstrued to be investment advice. If you'd like more information on Money Owners coaching, the podcast, the homework, and everything I have to offer, visit moneyowners.com.

Morgen Rochard:
What is happening, my fellow money owners? Today is Q&A day. So every five or so episodes, we do Q&A. I submit something on Twitter, ask for questions, I have a queue, people submit them on the website, they go to money owners.com/askmorgen with an E, and we've got some really cool questions, and, yeah, let's just dive right in.

Morgen Rochard:
So first question: what are your opinions about monetary base expansion, negative bond yields, and the "everything bubble"? Could this continue for a few decades? What would be your version of a permanent portfolio?

Morgen Rochard:
All right, so let's start this question with nothing I'm about to say is investment advice. I know I typically say that at the beginning of every episode, but I just want to remind you that this is not specific investment advice, this is just general information about the economy/ a specific portfolio, the permanent portfolio, and we'll get into that later. But yeah, not investment advice here. So monetary base expansion, I would start with saying there was something called the QE, quantitative easing, where the Fed was buying bonds of money that they create, a.k.a they print the money, and thereby making it easier for U.S. businesses to borrow money. So that's what it is in principle.

Morgen Rochard:
I mean, the other thing that they are doing, too, is that they're keeping interest rates at pretty low rates relative to what they've been historically. If you want some more information on this, check out my podcast, I forget which number it was, but it's the one that's Politics Don't Matter. I think it was 22. Sorry, I didn't write it down, but yeah, check out more on that if you want to hear my opinions about how to approach political things going on or what's going on in the economic climate and how to sort of apply that to your finances.

Morgen Rochard:
But yeah, in this specific question, we're just going to talk about what that means and how I'm thinking about it. So basically, why are they doing this? So what they're doing is that they're trying to basically make the U.S. dollar more attractive to foreign investors. And this in turn makes U.S. exports less expensive, it also helps U.S. businesses and also individuals to borrow money at basically ultra-low rates relative to what they've been over time, and all of this is supposed to help stimulate the economy.

Morgen Rochard:
The issue that we talked about in Politics Don't Matter is that we are at all time low in unemployment numbers, the economy is booming, so to speak, so it's a little bizarre that they're doing this. That being said, it's not a super issue. And one of the things in this question is: could this continue for a few decades? And in my mind, I think it can. Yeah, in my mind, this can go on for a few decades. I don't know the future. I don't pretend to know the future and anyone who pretends to know the future is basically lying and making stuff up, and that's what I believe about these pundits who are predicting things all the time and telling you that they know. They don't know. And what's the term that people say? A broken clock is right twice a day.

Morgen Rochard:
So, I think if we look back on it, right, a lot of the people who were able to call, let's say, the 2008 crisis, they weren't necessarily right on when they were supposed to get back into the stock market. Other economists and other people who called other crises were then poor at coming in, let's say, for the 2008 one that happened. So I think what we can tell just from past history is that people who make predictions are generally not right more than once, and sometimes they're not even right once. So that's something to consider when we're thinking about all these things, and my specific opinion on it, it really doesn't matter in the grand scheme of things. It doesn't actually change how I am doing things for clients and how we're thinking about investing.

Morgen Rochard:
So that being said, Trump is urging for another round of quantitative easing, bond purchases for 2020. I don't know whether or not that's going to happen, but that would in turn inject more liquidity into the current economy. And yeah, I mean, this could go on for a long time. It really could. I think the issue would be if people don't actually want to hold U.S. dollar anymore, that would really be when this sort of all gets wrapped up. I don't know necessarily what will cause people to not want to hold U.S. dollars, but that in my mind is really going to be what the end of this is. And until then, I think the song and dance continues, for sure.

Morgen Rochard:
And there are things that we can do as individuals to help deal with some of that stuff. So the first thing being diversification, always, and that means buying more than just U.S. companies, making sure that you're buying stocks on all spectrums of company size, company location, value versus growth. You want to basically be as diversified as possible when it comes to owning stocks. Probably the same thing if you're owning some bonds, you want to be diversified when you're owning bonds. You want to own on the short end of the curve, you want to own the long end of the curve; you want to own every end of the curve, and you want to do it in a way that helps you.

Morgen Rochard:
So something that the industry calls asset-liability matching, is how I approach it for most of my clients. So what we do is we sit down and we create a portfolio that specifically matches what they are looking to do in their life. So if they have a long-term goal, we match it with a long-term asset. If they have a short-term goal, we match it with a short-term asset. And that way what happens is that if some sort of global epidemic happens, we're not taking money from long-term assets because we planned for short-term. And that's something that you should be doing in your own portfolio. Again, not investment advice. If you need help on that, that's something you should seek help with a financial planner or do some more research on what's long- versus short-term assets, and how it would apply to you.

Morgen Rochard:
The other thing you have to keep in mind when you're doing stuff like that is your actual risk tolerance. So it may be like, hey, the only goal I have is to retire, in let's say 30 years, in which case you can own very long-term assets except that you have the risk tolerance of somebody who can't actually do that. So asset-liability matching has to be actually combined with risk tolerance to create the portfolio.

Morgen Rochard:
And I will do more on this in a minute, but let's get into the permanent portfolio. So Harry Browne created this permanent portfolio and basically what it is, is it's 25% U.S. stocks, 25% U.S. Treasury bonds, long-term bonds, though, not short-term, like 10-year-plus or 30-year, 25% in cash, and 25% in gold. And basically what he says is that you can own this portfolio. He basically gives investment advice to people, and what Harry Browne says is, "Hey, anyone can own this, and they can own it for a long period of time, and this works," and I think the key thing being long period of time.

Morgen Rochard:
And people find this portfolio to be particularly interesting because it has a lower return over time, for sure, relative to, let's say, a typical 60/40 stock/bond portfolio, but it also has a lower standard deviation, giving it a higher Sharpe ratio, and the Sharpe ratio is basically a return per unit of risk, and risk is being measured as standard deviation, which is just how much the price of something fluctuates. So I would say that this is actually a pretty undiversified portfolio, in my opinion. You're holding 25% of your assets in U.S. stocks only. Typically in my portfolios, it's 13,000 companies and them all over the globe. So to me, this seemed crazy low. Also, only U.S. bonds, that seemed pretty crazy to me considering that the global market is not just the U.S. I don't know the numbers off the top of my head and I should have pulled it, but it's only about 35% to 40% U.S. bonds to begin with, and a subset of that would be the U.S. long-term Treasury bonds, in which case I think that you're basically ... you're nixing out a significant portion of the bond market.

Morgen Rochard:
25% in cash seems pretty high and seems like something you want to do asset-liability matching on rather than just keeping that around your portfolio. And then gold is one of these things where, I mean, you really got to time that asset. And I don't think I've said this on here before, but I'll just say it now. I mean, I really don't like owning anything that I don't want to own for 30-plus years. I don't like doing market timing in general. I think market timing is a good way to basically get myself in trouble, and I think most people do get themselves in trouble with market timing. So if I'm thinking about a risky asset like stocks or gold or something like Bitcoin or really anything ... real estate, right? These are all things that are riskier than, let's say, bonds, which I mean, I'm not going to get into obviously because of everything that's going on with the negative interest rate environment. That's a whole other thing.

Morgen Rochard:
But typically these are assets that are considered more risky because they move around more and they have different price discovery going on all the time, whereas bonds are ... they pay a coupon, and they're generally stable over time, right? Assets that move around. These are things that if you're not willing to hold them for a long period of time, you have to be a good market timer. And if you're not a good market timer, which pretty much none of us are, then you're going to get a poor return. Gold is exactly one of those things. So long-term return of a real asset like gold is really only supposed to be inflation, and right now that's running less than 3%. So I don't think that you can actually expect much of a return out of gold other than what inflation is going for because that's basically what gold is, inflation protection. So I would say when you're considering putting 25% of your portfolio in gold, you either need to be really good at market timing, which none of us are, or you have to just be willing to accept a very below market return. So those are things to consider when you're considering the permanent portfolio.

Morgen Rochard:
To get back to asset-liability matching. I really think that's the way to go. You can create your own permanent portfolio, but again, that's like me giving investment advice. I think the permanent portfolio that I like to create is very individualized. It's based on what's going on in a person's life, what goals they're saving for, how far out that goal is, how much money that goal is going to cost. And then we design the portfolio around that. And we don't make very large asset allocation changes in that portfolio unless something in that person's life changes.

Morgen Rochard:
So here's an example: imagine you're a 35-year-old man, you have a 35-year-old wife, you have two young kids at home, you want to buy a house. You want to buy a house, let's say, in the next four years, let's call it. And you also want to save for retirement, you want to retire at the age of 65, so in 30 years. And you also want to pay for your kids' school and your kids are young, but let's just say that they're going to college in 15 and 12 years, something like that. So we've got a bunch of different periods of time, right? We have the four-year period of time for the home. We have a 12- and 15-year time period for the college. And then we have a 30-year time horizon for retirement. Let's assume that their risk tolerance is also somewhere moderately aggressive to aggressive, okay, because if we throw conservative in there, things really, really change, and I really want to talk about asset-liability matching at its finest, not asset-liability matching with the risk tolerance overlay over it.

Morgen Rochard:
Okay. So for the four-year time horizon, right, there's not really that much that you can do with that money. So the best thing you could do would either be to buy bonds that would mature in four years so you'd have that capital to go and buy the house with it and you would earn interest along the way, or you just put it into one of these high-yield savings accounts or a money market account that's earning 2% or whatever it is earning right now. And you keep putting cash in there until it comes time for you to make a down payment. That would be what you would do. Anything really with five years or less time horizon, there's not that much you can do because the stock market can do all sorts of things over five years. And frankly, you don't want to be selling at the worst possible time when you're going to make a down payment. That's the idea behind that in an asset-liability matching scenario.

Morgen Rochard:
The next thing, thought, would be kids' college, right? So those 12 to 15 years. That's a longer time horizon, for sure. I tend to think that that's not long enough when it comes to stock market returns. So we wouldn't be 100% in stocks, but we'd probably look closer to, let's say, a 70/30 portfolio or 80/20, 80% stocks, 20% bonds, depending on where we were. Maybe for the 12 year it would be more like 70/30, and for the 15 year, more like 80/20. That probably would make sense. If they were feeling particularly aggressive, maybe we would do 100%, but honestly, I don't necessarily think that that would be the right thing.

Morgen Rochard:
For the 30-year time horizon, given that they have an aggressive risk tolerance, we would be thinking about piling basically into stocks or something like Bitcoin, or really some real estate. Actually, real estate you can put in into the 12- to 15-year portfolio as well. But pretty much anything above that five-year portfolio time horizon, you could start playing with some of these risky assets and combining them with other things with cash flows.

Morgen Rochard:
That would be the idea behind asset-liability matching. That was not investment advice. That was just an example of a couple and certain things and the ways that you can look at it. You can apply this to your own situation, for sure. It's not going to look exactly the same as this made up couple, obviously, but if you have more questions about your specific situation, definitely seek the advice of a financial planner because this is investment advice and that's not something that I actually can give on this podcast.

Morgen Rochard:
Okay, so I hope that answered your question. If not, submit a new one. All right, next question: "Morgen, after listening to this podcast, my wife and I realized that we have competing goals. She feels very strongly about sending our kids to private school, while I very much want to buy a bigger house, how do we decide what to do? We can't exactly compromise on these items as we don't have enough money for both."

Morgen Rochard:
All right, so good question. Compromise. No, I'm just kidding. I know you can't do that. This is actually something I've seen in my practice quite a bit. I mean, not this specific example, but where couples, they ... You come into a marriage, right? Two people meet, they fall in love, maybe they come from different backgrounds or maybe they come from the same background, but even if they come from the same background, typically how they handled money growing up or how they were taught things about money or what they were taught to value in regards to money is different. So even if, let's say, you had a very, very similar upbringing, with the exception of marrying your cousin, which we don't really do anymore, I think that you would find it pretty hard to find somebody with exactly the same background as you. And I think that we can even, if you look at, let's say, how your cousins were raised versus how you were raised, probably same thing because the temperament of your parents are probably very different from the temperament of your aunt and uncle.

Morgen Rochard:
Okay. So that said, the first thing I would think about is can you increase income? So, obviously one of the greatest ways out of this situation would be if you were actually able to make more money and thereby able to both afford the bigger house and send your kids to private school. The other thing that you can do is you can evaluate spending. So maybe you can afford both the private school and the larger house if you change some spending things on the other side. That said, we've actually talked about this in some other examples and it's actually much easier to change the fixed expenses, the large fixed expenses like the house and like private school, than it is to change the other variable, day-to-day expenses like groceries and dining out and coffees and all those other things that we talk about when we typically say that you should save money.

Morgen Rochard:
I would say it's definitely easier to start with the large, fixed expenses. So if you're not already in the situation where it sounds like from this question that you haven't pulled the trigger on the bigger house or sent your kids to private school, you're actually in a good place to decide which one is more important to you. That's said, I mean, I don't really know you guys, right? The one thing I would say is that it probably is going to involve many conversations where you see each other's positions from each other's eyes. So it's not enough to just be like, "Hey, I want this larger house because I want more space," which I know maybe sounds like enough of a reason, but dig deeper. Why do you want more space? What about the space is valuable to you? Is it that you want to place the store things in your house or is it that growing up you had this idea about what you were supposed to have in a house?

Morgen Rochard:
And I mean, you could, I guess, go down the list in your mind, like really take this to the logical end conclusion of like, what is it that you want out of the bigger house? And the same thing with the private school, right? You can't just say, "I want this because I want my kids to have a good education." That's great. But there are also many ways for your kids to get a good education, right? One of the ways for your kids to get a good education is they can go to public school and then you guys as parents can do all sorts of things on weekends and in free time or even take your kids out of school for a special day where you learn different things. Learning can happen really anywhere. So yeah, on the one hand, there are many good things about private school, but on the other hand, it doesn't have to be the only thing.

Morgen Rochard:
So I think when you're saying, "I want this because I want my kids to have a good education," you actually need to take it a little bit further than that. What about the education was really important to you? What about it do you value? And the other thing that's worth calculating is how much income you need to maintain to send your kids to private schools and also, let's say, to have that house. So one of the things, right, that we don't really think about when we don't have these expenses yet, is hey, if I send my kids to a private school or I take on this new mortgage, I now have to make, let's, say an extra $50,000 or $75,000 extra per year, and I have to continue to maintain that so my kids can either continue to go to that private school or I can continue to pay that mortgage.

Morgen Rochard:
That might be right for you guys if that's really all that you want. But if, let's say, you have another goal, like, hey, in five years I want to start a business, or in five years from now I just want to quit my job and start writing and see if I can make a go at that. Or in five years from now, I want to take a trip around the world and I want to have money for that, right? I'm just making stuff up. I mean, I don't really know what's going on in your situation, but these are things to think about when you commit to large, long-term expenses, right?

Morgen Rochard:
So it's one of those things where you can't really just send your kids to private school for two years. You have to send them for all of the years that you're committing. Once you kind of put them in, they make friends, they get entrenched, they start doing things with their friends. It's really hard, let's say, to put your kid in at fifth or sixth grade, if it goes to 12th grade, and then pull them out being like, "Hey, I ran out of money." That said, if that is your situation and you have run out of money, you should pull them out. I'm just saying I understand from the perspective of parents why they wouldn't necessarily want to do that. And I've even seen parents take on debt so they can avoid having those conversations with their kids. So all things to think about when you're taking on a larger expense, like a private school or a home that's going to be over a long period of time.

Morgen Rochard:
And the last thing I would say is you really just need to come around to a decision that makes the most sense for your family. The number one question I would ask is: what is most important to your family? Is it the house? Is it education? Is it something else? What does the education mean for you? What does the house mean for you? These aren't questions that I can necessarily answer, but this definitely is a conversation that you need to be having on a regular basis, and you need to know that you're not going to come to a decision overnight, that this is probably a conversation that's going to go on, I would imagine, for at least a year, and maybe longer than that.

Morgen Rochard:
So just keep that in mind when you're having discussions and just be open to each other and loving. You know that you're on the same team, right? You both married each other, you obviously love each other, you have kids together. Sometimes it helps to name your household. My husband and I have done that. We have named our household and I get reminded when I think of our team name that we're on the same team, we're in this together, we love each other and we want to make sure that we're doing it. So I think sometimes we forget that. When we're arguing with each other, we think that ... I don't even know what we think about, honestly, but we never think in our heads, "Oh, we're on the same team. Maybe we can figure this out." And I think sometimes it just takes one person backing down a little bit from that fight, just a little bit, just to back off, to get a little bit more clear and be able to have just an easier conversation about these things.

Morgen Rochard:
Okay. So I hope that helps. Next question: "Hey Morgen, I drive a truck. I make a really good living driving, but everyone keeps telling me that my job is going to be replaced by driverless cars. What would you do if you were me?"

Morgen Rochard:
Awesome question. Thanks for submitting this. So I wish I had a really good answer for you. I have a sort of good answer for you. So, I think the number one thing that you should be focusing on is having a really good emergency fund and savings in place so that when this does happen, and I don't know when this is going to happen and I don't think you know when this is going to happen, but maybe sometime down the line, we all think ... Generally, the people who are in technology think that these things are going to happen much more quickly than they do. And generally, people who are ultra-conservative and don't want to see it coming, think that it's going to happen much later than it actually does. And somewhere in between is probably when it will happen, so just keep that in mind. But the best thing to have is a good emergency fund.

Morgen Rochard:
So what do you need to do to do that, right? You have to make sure that you can get everything that you want out of this life, when the time comes, and that you really can spend the time with the fund that you have, to decide what you actually want to be doing in this life. So I would say that savings is the best way to have flexibility and optionality around really any job loss situation. So yes, you have a little bit more wherewithal about what might be happening down the line, but you don't necessarily have a time horizon. Somebody else maybe is just going to get laid off tomorrow, and if they don't have any emergency fund in place, it's going to be really hard for them to be able to reassess where they are, think about where they want their life to go, and then make decisions from there about how they're going to proceed.

Morgen Rochard:
And I mean, I would say it's an opportunity for you. So I know this is something that we've talked about before and something that I mentioned about Jocko podcast where he says, "When going gets tough, you got to say to yourself, 'Good.'" And I actually think that the answer to this is really good. What do you want to be doing in your life? Have you always wanted to be a truck driver? Is that really what your dream has been in this life? And if it is, that's great and I'm glad that you've fulfilled it, but maybe now you get to take on another dream, maybe your dream of what it was before could just be, and it could just be something that you're nostalgic about when the change does happen. But now you get to spend time, and if you're really good about saving, you'll actually be able to take that time where maybe you go take new classes to learn something else that you want to do or you just take some time off and you travel, because you can finally do it because you have some money in the bank. And maybe while you're spending all those hours driving, you could really think about what it is that you want to be doing next. And once you've found that thing, it'll actually be much easier to save for it.

Morgen Rochard:
So it's easy to say, "Hey, have some money in the bank," but if you really know what you're saving for, then maybe you can save for that program, let's say, that you want to spend money on so that you can learn new skills. Or maybe there's a hobby that you've always had that you think you can turn into a business, and savings would help you do that. So definitely assess what's going on in your spending pictures, see where you can maybe cut some corners and save a little extra money so you can put it away, save for a rainy day. That would be my number one advice.

Morgen Rochard:
I actually just had a friend that went through this, so she saved roughly two years' worth of her expenses at her previous job, and then she was unexpectedly laid off. And she had saved two years' worth of expenses ... She said, actually it was kind of funny how she put it. She was like, "Yeah, I just didn't spend it. And that's what happened. It wasn't really planned," which I was find amazing, when like people ... they're kind of in their own world. They're not really spending as much as they make and they just amass a bunch of cash and they didn't really even think about what they were going to do with it. Well what was nice for her was she was unexpectedly laid off and then she got to travel for six months while she interviewed for new jobs and found the next that she wanted to do.

Morgen Rochard:
So that's actually my hope for you. I think it's possible for us to think about it that way, and I think that it's just all about how you think about it. If you're thinking about it like, hey, I'm going to lose my job and I'm going to be replaced by this driverless car, and what am I going to do next? And you're really moping about it and feeling sad about it and not really thinking of it as an opportunity, then yeah, it's going to be like that when it comes, and it doesn't matter when it comes. It doesn't matter if it comes in one years, five years, 10 years, or 30 years from now, right? If you're not working on how you're thinking about it and thinking about it as an opportunity of all the new things that you can do, then I think it's going to be really hard. And if you know you're in an industry like this person that is potentially vulnerable to things like a robot or a driverless type of a scenario, maybe it's time to start saving and thinking about what you want to do next. All right, so I hope that answers your question and if not, send me another one.

Morgen Rochard:
All right, next question. "Hey Morgen, I am being offered stock options as part of my compensation package for a new job. I don't know how to evaluate this at all. For some context, I am being offered some restricted stock and some non-qualified stock options. Can you give me some advice?" All right, great question. So these are actually extremely complicated, and I will do my best. I'm actually not an expert on these things, but I will do my best to answer this question. If you have more questions, definitely resubmit them.

Morgen Rochard:
The number one thing to think about is, so restricted stock is basically like getting cash. So if you work for a public company, which is typically who issues restricted stock because you actually have a market for that stock and that's how they're able to do it, basically what happens is that, let's say, you get paid $150 grand a year and then you also make $50 grand a year in restricted stock. It's essentially like you're making $200,000 a year. And what happens is that when you get issued that stock on the vesting date, that stock is literally compensation to you. So basically, you pay tax when it is earned and you pay tax as though it were income. So essentially what happens, right, is let's say in this example, you make $150 grand and you get $50 grand in restricted stock. You're taxed as though you have $200,000, but $50,000 of it is in stock. So you're going to be paying more in taxes as a percentage of, let's say, actual cash, which is the $150 grand that you make an income. But that said, you are earning $200 grand total.

Morgen Rochard:
Some things to think about, this is not investment advice, but I have seen this happen with clients, who get restricted stock is they get it at the beginning when they're working at the company and they don't do anything with it because they don't know what to do with it. And typically, also if you're working for that company because you believe in the company, so I've seen this happen to people who own Amazon stock or Google or any of these large tech companies where they're issuing restricted stock, you just end up holding it. So what happens is, let's say, in this scenario where you have $150 grand that's coming in in income and then you have the restricted stock, you just pay more in taxes from the cash that you have. You hold the stock for a really long time and then, let's say, the company has appreciated in value. Now you basically have a significant portion of your net worth in that company stock.

Morgen Rochard:
So something to consider ... Not that like Google, Amazon or any of these large companies are going out of business, but it is possible that they do. So something to consider if you're not directly affecting the bottom line of the company, it might be a good idea to at least sell all or at least most of the shares that you get as you get them. Because basically if the company goes belly up, you have not only lost all of your savings but you have also lost your income. So it's like a one, two punch.

Morgen Rochard:
Actually, there was this guy I went to college with, I don't remember his name, but he's a legend because of what he did with his signing bonus. So he got a job at Bear Stearns. This was in, I want to say, like September or October of 2007, and he took his $10,000 signing bonus and he bought Bear Stearns stock, and he was so proud and everyone thought he was so cool because he was working at Bear Stearns and all this stuff. And I remember really feeling jealous at the time because I didn't know what I was doing and I didn't have a job and everything else. And yeah, in March of 2008, Bear Stearns basically went out of business. And not only did that kid never get to go to his first day of work, but he lost his $10,000 signing bonus.

Morgen Rochard:
And I actually think that was one of the best lessons I ever got at a young age, because I mean, I was basically a senior in college when I heard this story. And it stayed with me actually my entire career because whenever I was offered stock, I always sold it immediately out of fear of the company going bankrupt and me not having savings and not having a job. So just something to consider. That said, that doesn't mean you have to sell all of it, but it is a good idea to be thinking about: what portion of my net worth do I actually want to have in this company stock? Because most people don't wake up saying, "Hey, I wish that 95% of my net worth was in Amazon."

Morgen Rochard:
I mean, I think some people do, they wish that because they wish they bought Amazon at $40 and then held onto it forever. I think that's what people think of when they typically think of this, but they don't think of it as, hey, you got some of this stock as actual compensation for work that you've done, and then it's appreciated to a point where, yeah, it's hard for you to sell the shares now because of the tax implications of it. And you also probably want to use that money for something else because you don't want to be holding, let's say, one company forever. So just something to be considering when you get RSUs.

Morgen Rochard:
But yeah, taxes aside, RSUs are basically like cash, and you essentially should consider it to be that. Nonqualified stock options are a little bit different. So let's just walk through what they are and then we can walk through the taxation of them, and hopefully that answers your question on how to be thinking about these things. So, let's go back to our original example. Let's say you make $150 grand a year, but in this example, for my pea brain, let's make the math easy and say that you also get 10 options that vest. And typically what happens is that you get a vesting schedule and you get, let's say, 10 options every quarter or something like that. I mean, it depends on your compensation structure and everything else. There are time limits and time periods to all of these things, all that stuff will be in your documentation. For the purposes of this example, let's just say you make $150 grand in one year and you also get 10 options that vest in that year as well.

Morgen Rochard:
Let's also say that those options vest and they have a strike price of $10. So what this means, if you have 10 options with a strike price of $10, it means that you have the option to purchase 1,000 shares of the company at $10. And I'm going to repeat that. You have the option to purchase 1,000 shares of the company at $10. So that means that you lay out $10,000 to buy the stock. I think this is the number one misconception. Once I tell you this, right, you're like, "Oh yeah, of course, that makes a ton of sense." But typically when people think of options, they just think of free money, and it's not. It's the option to purchase stock at a certain price. And after you purchase that stock at that price, you have the option thereby to sell it, hopefully at a higher price.

Morgen Rochard:
So that's usually the hope, but still, you lay out the $10,000. So let's say you don't have the $10,000. That could be the case, right? So typically if you're exercising it, it probably means that the ... So the strike price, let's say, it was $10, but the stock price itself is, let's say, higher than that, and that's the reason why you're exercising. So exercising means that you take the right that you have to buy those shares; exercising is actually you taking that right to do it. I know there's a lot of lingo and it gets really technical. And the strike price is the price at which you are allowed to buy the stock, given the contract. But the company price, the market price, is whatever the company is at at that given period of time.

Morgen Rochard:
So let's say in this example you have a strike price of $10, but the company price in the market is $15. So what it basically means is that you would lay out $10 grand to be able to buy the stock at $10 and then have the ability to sell it at $15 because that's where it is in the market place; thereby you'll make $5,000. You have the ability to do that same day, so you don't actually technically need to lay out the $10,000, but typically what happens is that you do actually lay out the money and wait and all this other stuff. It depends on what's going on in your financial situation and how you decide to do it, but I just wanted to give you some details on it.

Morgen Rochard:
So basically if you get a strike price of $10, it doesn't make any sense for you to be exercising the options unless it's "in the money." So in the money means that the market price of the stock is above $10. If it's out of the money, it means it's below $10. So there's a little bit more going on here than, let's say, you just get issued some restricted stock that's like cash to you, and that's pretty simple to think about, and it's just like cash compensation; like everything else, it gets put on your W2. Nonqualified stock options, they also typically get taxed. They also are taxed as ordinary income at the exercise of the option. So let's say you exercised the thousand shares at $10, that means it's basically $10,000 to you, and that's what you're taxed. Yeah, I know it's crazy to be thinking about this. Then, right, if you sell for a profit, then you are also taxed on that.

Morgen Rochard:
So these are all things that you need to be thinking about. Typically, the thing to be thinking about, the RSUs versus the nonqualified stock options, is that you get to choose with nonqualified stock options, when you get taxed, whereas with restricted stock, you don't. With restricted stock, as soon as it vests, that's the year that you get taxed, whereas with nonqualified stock options, you get taxed in the year that you actually exercise. So the thing that's nice about the choice is that ... To some extent you have a choice, right, because the option has to be in the money. But to other extents, let's assume that the stock price is always in the money, you get to decide whether or not it's the right tax year for you to be doing it.

Morgen Rochard:
So I think when you have these things, the number one thing to consider is that it probably makes sense to work with an accountant. And the other thing to consider is that nonqualified stock options are usually undertaxed. They typically use the 22% tax rate. I've seen really large tax bills for my clients that's not addressed through quarterly payments after the options are exercised. So it's basically, it's not as much free money as you think. Whereas restricted stock is typically thought of as free money, nonqualified stock options ... options in general are not.

Morgen Rochard:
So I would say when you're thinking about your compensation package, that's how I would think about it. I would think about it as like, okay, hey, RSUs, extra cash for me; nonqualified stock options, kind of a whole other lot of stuff going on. It doesn't mean that I don't want to own equity in the company, and that is worth something to me, but it's not worth as much as you think. It's not worth the paper value that people typically think that it is. It's worth the difference between the stock price and the value of the exercise price. And these are all things to really be considering when you're considering what is a good compensation package for yourself.

Morgen Rochard:
The other thing I typically see, so this is probably not going on in this specific example, but where companies issue options only to my clients instead of the restricted stock. Usually options are given out when the company's a startup, or some sort of equity is given in the company as a way of basically under-compensating a person for their time, with the hopes that that startup will eventually become something big and then that person will actually own a bunch of money. I would say you have to really, really love what you do for that to be willing to be under-compensated, and really, really believe in the company, because a lot of times this stuff doesn't really work out and then you're just working for less than you would maybe otherwise make in a different job.

Morgen Rochard:
There are definitely reasons to do the job. I would say you really like the product, you really like the role you're going to be doing in the company. Maybe you get to wear multiple hats because it's such a small company that you're able to do multiple things within the company, so you get to see a lot of different things. There are a lot of reasons to work at a startup. Owning equity in one of them, I would say, isn't the reason why you would want to do that. It really is more the love of the job, the people you're going to meet, the work that you're actually going to be doing. The money is sort of secondary to that, whereas when you work at some of these more established companies, the money is more of a more of a big thing and that's typically why they give restricted stock.

Morgen Rochard:
Sorry, I realized as I'm wrapping up this question that I've actually misspoken a little bit on the question. So, let's get back to the option pricing. So basically, if you have a strike price of $10 and the stock price is worth $15, I said that you would get taxed on W2 income at the $10,000. That's wrong. I'm sorry. I don't know why I even said that. You would get taxed with the difference between the $15,000, which is where the stock price is, and the $10,000, which is the strike price.

Morgen Rochard:
So something to consider when you're thinking about these options is that the tax implication is going to be the difference between the market price and the exercise price of what was given to you on the grant date. And these options are typically ... They're pretty complicated. And I guess some other things that I wanted to add about this is there really aren't a lot of financial planning considerations to these things. So there are definitely advantages to stock options, right? You get increased income, for sure, which is really nice. There's tax deferral associated with it, we've talked about. You can basically decide when you want to exercise and sell. And there's some tax deductions associated with them, but these are things that you definitely want to be discussing with an accountant. But the other things to be considered, right, is there's more diversification, much like the restricted stock that we've been talking about.

Morgen Rochard:
And there's really no guarantee about this. So if the stock price does drop below the exercise price, it is possible that you never really see any money from this. So I know I mentioned this already, but there are significant disadvantages to stock options versus restricted stock that actually has a typical market price that's out there. And the cash requirement for the exercises, it's not always something that employees are able to come up with. So it is something to think about if you want to make sure that you're in a situation where you're able to actually be able to exercise these options, maybe you have to be saving for that day. And I mean, these definitely cause tax problems for people in higher income tax brackets.

Morgen Rochard:
So I would say if you are confused about what's going on with your stock options, it definitely makes sense to seek out a financial planner who knows what they're talking about with these things, who knows what to look at, who's seen what the taxation looks like, who can look at your entire plan related to it and see how it makes sense to you, and how you should be thinking about it. And I think that's all I'm going to say about that specific question. All right. So I hope that answered your question. If it didn't, then send me a note.

Morgen Rochard:
And we blew through four questions, wow, because I feel like normally I talk and talk and talk and it takes about 45 minutes for me to get through them, and then I can't get through any more questions. So I actually didn't prepare anything else, so I'm going to leave it at that. If you liked what you heard on this, and you want to have one of your own questions answered, you can find me on Twitter at Morgen, with an E, Rochard, or at money_owners. You can also submit your question online, moneyowners.com/askmorgen, don't forget the "ask" part.

Morgen Rochard:
And yeah, I got a bunch of really cool stuff coming up, some nitty-gritty behavior stuff that we're going talk about in the next four episodes. And yeah, if you liked the show, tell a friend, write a review, give me five stars, all of that good stuff. And I hope to talk to you guys in two weeks. All right, bye.