Learning how to save, nine years later

I always expect, after recounting my financial chores from the past year, that the next will be simple and uninteresting. That all I will have to write in 12 months is, “I worked a lot and saved a little.” Instead, it seems, each year I confront new challenges, learn the details of increasingly complex financial acronyms, and continue to fine-tune my savings strategy. This, my tenth such dispatch, is no different. (You can read my first here.)

401(k) and IRA

As planned, at the beginning of 2015 I rolled my defunct ProvideCommerce 401(k) balance over to my Roth IRA at Schwab, before discovering that Provide’s private equity owners had failed the nondiscrimination test for highly-compensated employees, thus lowering my contribution limit to below what I had contributed, (and far below the maximum normally allowed by the IRS). The difference had to be removed from my IRA and will be treated as untaxed income in 2015. Thankfully it wasn’t very much.

I’m told that historically FTD has passed this test because they automatically enroll all employees in their 401(k) plan. For that reason, and the fact that Stephanie’s not currently contributing to a retirement account of her own, 2015 was the first year in which I aimed to reach the 401(k) contribution limit.

The rolled-over funds in my Roth IRA, plus my contribution for 2014, represented the first time I had a lump sum of cash that I wanted to invest—just not all at once. I’ve long been a proponent of dollar-cost averaging, but mostly out of necessity, as I usually only have a small sum of money available to invest each month (courtesy of my paycheck). This opened the question: over how long a period should I spread the purchase of index fund shares? Conventional internet wisdom seemed to suggest around 6 months. I ended up scheduling the purchases to happen twice a month through the end of 2015.

HSA

After breaking my elbow in March, I learned that I could make a lump sum contribution to my health savings account (HSA) for 2014 up until tax day in order to max it out, which I then turned around and immediately used to pay the entirety of our family-size deductible—elbow surgery ain’t cheap. I also increased my monthly contributions to max-out the account for 2015, and will continue doing the same for 2016, under the assumption that our medical expenses will only increase as we get older.

ESPP

In July I became eligible to start contributing to FTD’s employee stock purchase plan (ESPP). Here’s how it works: Over any 6 month offering period, Jan–Jun and Jul–Dec, I can choose to contribute from 1–15% of my after-tax salary to the ESPP. Then on the last day of the offering period (Jun 30 and Dec 31) the money I’ve contributed over the previous 6 months is used to purchase shares of FTD’s stock—at a 15% discount.

Now here’s where it gets tricky. The discounted price is based on whichever is lower: the stock price at the beginning of the period or the stock price at end. This means that no matter what happens to the stock during those 6 months, I’m “guaranteed” a return of at least 17.6%. And when the price rises, I get that gain that too.

Why 17.6% and not 15%? The easiest way to explain is with an example. If you sell me a $1 chocolate bar for 85 cents—that’s the 15% discount—and then I immediately turn around and sell it for $1, what percent have I earned? Well, I gained 15 cents from my initial “investment” of 85 cents. Thus I’ve gained 15/85 = 0.176470588…, roughly 17.6%.

That 17.6% (or more) is an unrealized gain. Until I sell the stock, my return is at the risk of the market. Though people can choose to hold onto their shares (in hopes that the stock price will rise, for more favorable tax treatment, or just for a sense of ownership in the company), I’m of the mind that a “guaranteed” 17.6% return is gain enough. I’m already deeply invested in the company as an employee, my salary and bonus are already tied to company performance, and thus holding onto the stock would represent too much exposure to a single equity. So I’ve configured my ESPP shares to be sold immediately after they are purchased (something I had to do via an instrument called a 10b5-1, because as a manager I have access to financial information about FTD, and thus have to follow strict rules to avoid the appearance of insider trading). As I understand it the 17.6% gain is taxed as ordinary income, while any additional gain due to the stock price rising would be treated as a short-term capital gain, unless I held onto the stock for more than a year.

What does this all mean in actual dollars and cents? Let’s imagine someone who earns a salary of $50,000/year and chooses to contribute 15% (the maximum) to their ESPP. At the end of 6 months, they’d have contributed a total of $3750. Assuming the stock price remained flat, the “guaranteed” return of 17.6% would net them $660 ($1320 for the year). Compared to the $17 they’d earn from a 6-month CD with a 0.9% APY, you can see why ESPPs are such a great deal. It’s effectively a voluntary 2.6% pay raise.

Update: So how did things turn out for me in practice? Well, I learned that the ESPP market isn’t perfectly efficient. The offering period ended on Dec 31, at which point FTD stock closed at $26.17/share. Since that was lower than at the beginning of the period, that was the price upon which the 15% discount was calculated. Thus the money I had contributed over the 6 month period purchased stock at $22.24/share. Unfortunately, this purchase didn’t go through until January 6 and the automatic sale triggered by my 10b5-1 election didn’t happen until mid-day on January 7—a seven-day period in which the stock lost 5% of its value (due to a market-wide decline). In the end, my discounted ESPP shares were sold at $24.86/share, a gain of only 11.8%. I still made money, just not the 17.6% I expected. Hence the scare quotes I applied liberally around the word “guaranteed” above.

2016

I will continue to max out my 401(k) and HSA contributions as long as I’m able. I will also continue to contribute the maximum allowed to FTD’s ESPP—why pass up free money? The ESPP earnings help pay for Stephanie’s tuition and books (which may rise considerably if she gets into SFSU in the fall). Any bonus I receive will help pay for some home improvement projects we’re planning. Should be simple and uninteresting, right?

Update: Learning how to save, ten years later

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