Not everybody is fortunate enough to have access to an Employee Stock Purchase Plan. But if you are, you likely have benefits that give you between a 10% and 15% discount on the lowest price of your company’s stock over a six month period. Normally this is limited to a maximum of 10% of the employee’s annual salary.
It turns out that the typical ESSP is the best investment deal you will likely ever find and is one of the best sources for building up your retirement portfolio. The following example shows why:
Lowest stock price during six month period: $20
Number of contributions from employee: 12 (one contribution from each paycheck during six month period)
Dollar contribution per paycheck: $300
Discounted stock purchase price: $17
Stock price at end of period: $20
When can the employee sell the stock?: At end of six month period
A quick calculation of the total return from this plan gives us the following:
Total contributions = $300*12=$3600
Number of shares owned at end of period: $3600/$17 = 211
Total value of shares: 211*$20 = $4220
Total Return = ($4220-$3600)/$3600 = 17.22%
A 17.22% return sounds pretty good, especially since the stock price didn’t even go up during the period. But it turns out that the true annualized return is much better than this. In fact, it’s nearly 90%. Because the contributions were made over a six month period, on average the money was only tied up for three months.
Since there are four of these three month periods in a year, the annualized return from this ESPP is (1 + 17.22%)4 – 1 = 88.8%! This is hard for some to believe, but this is the true annualized return. The return is even higher if the stock price goes up from its lowest point during the period. Compare this to the typical annual return of a money market fund, which is about 0.1% currently. To input your own values please see my ESSP Return Calculator spreadsheet here.
Given the incredible returns that ESPPs can deliver, it makes complete sense to contribute as much as the company will allow to the plan. Employees should absolutely max out the contributions to plans such as the one used in the example above. The return from ESPPs even beat the return from paying down auto loan debt or credit card debt and is certainly better than investing in the overall stock or bond market.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.