Have You Claimed Your 10% Guaranteed Raise?

As a young engineer I worked for a really great medical device company.  However, we  happened to be part of a giant conglomerate called Tyco International.  If the name Tyco rings a bell, it’s probably because the once CEO went to jail for looting about $100M from the company.  Some of the crazy details included a “roman orgy” birthday party for his 2nd wife, a $6,000 shower curtain, and a $2,200 garbage can all paid for on the company dime. 

Strangely, as a far flung subsidiary, we knew nothing of this guy or his shenanigans.  When it all came to light, Tyco got new leadership and replaced 9 of its 11 board members.  All of us poor schmucks had to take extensive ethical training courses and we had super tight controls on all expense approvals.  Suffice it to say that there are certainly illegal and unethical ways to give yourself an unauthorized raise as proven by this example.  However, there are also 100% ethical and legal ways to give yourself an unauthorized raise.

In my “obligatory get rich in one blog post blogpost” I wrote about the importance of maximizing one’s salary. Back as a young engineer I was looking for any way that I could to increase my earnings.  I started looking closer into my company’s employee stock purchase plan (ESPP).  What I found was awesome.  The Company offered a 10% discount on company stock purchased through the plan as long as the stock was held for at least 3 months.  If the stock was sold within 3 months, the employee still got the 10% benefit but could not participate in the ESPP for one calendar year.  The idea that I came up with was bold.

ESPP Arbitrage

After 401k contributions, we would live off of a portion of my wife’s remaining salary and run my entire remaining bi-monthly paycheck into the ESPP.  After 3 months of doing this, I would continue putting every paycheck into the ESPP.  However, at the same time I would sell the stock purchased from a 3 months prior paycheck.  Each time I bought stock, I would sell the same amount (plus claim the 10% company match) FIFO on a 3 month lag.  This meant that at any given time I had 3 months worth of paychecks in the company stock. However, after the initial 3 months I was getting my paycheck every 2 weeks with a 10% bonus.  As long as I was buying and selling one paycheck worth of stock simultaneously I was collecting an extra 10% and any gains or losses would offset each other.  In theory, if I did this over a long period of time, I had a good chance of making money even if the price of the company stock went down substantially.  In the worst case scenario, if the stock price fell to zero overnight and the company went bankrupt, I could have lost 3 months worth of paychecks.  This would have been a tough loss and while rare it was a remote possibility.  However, I had another safety net in the ability to sell out entirely at any time and still get the 10% benefit.  I would simply then not be allowed into the ESPP for one calendar year as a penalty.  This meant that if I saw the stock starting to fall alarmingly (say 10% in a given week), I could sell out immediately kind of like a manual stop loss order.  Sure it would mean that I could no longer do the ESPP but why would I want to anyway if the stock was tanking.  I later learned that this general idea actually has a name and it is called arbitrage.      

Did ESPP Arbitrage Work For Me?

If you were looking for this to be a mister smartypants gets burned sort of story, sorry to disappoint.  The chances were that this was going to work in my case and in my case it did work.  The stock price did not change much and I effectively got a nice 10% raise over the year or so that I did this.  I then left the company and did an around the world trip, helped by this 10% raise.  Let’s look at some of the math from my ESPP scenario.

Surprising ESPP Math

Let’s say hypothetically that the stock price started at $100 and dropped 1% every paycheck (2% per month) over 2 years while I was doing this arbitrage plan of mine.  This would represent a 47% drop in the market cap of the company in a 2 year timeframe (pretty substantial).  However, as shown in this chart I would have still netted a 2% gain even in this situation:

It is also worth noting in the example situation from the chart above that if the stock price of a giant diversified conglomerate like my former company actually dropped 47% in 2 years this would either represent a fundamental problem with the company and valuation or alternatively a tremendous value opportunity.

Could ESPP Arbitrage Work For You?

Each ESPP is unique to that company and of course I am not a financial expert but simply a guy on the internet who did this several years ago. As a specific rule for this site and good general advice for the internet, it is fine to get ideas online but they may totally suck and/or not fit your financial situation. Make decisions for yourself based on your specific needs and situation. With that said, here are a few additional things one might consider:

Additional ESPP Arbitrage Considerations

• How stable is your company stock?  What would the outcome of doing this look like under various scenarios?
• How is your company ESPP structured?  Is there a cap on how much can be contributed?
• Do you have a cash cushion in order to be able to defer your paychecks through the ESPP?
• What is your tax situation and how will taking short term capital gains work for you?  What about a 12 month lagging arbitrage for long term capital gains rather than short term?  How much faith would you like to put into your company stock?
• What does your financial situation look like and what might make sense for you?
• How does the ESPP compare to other benefits that your company offers like 401K or FSAs for example?

Other Instant Raises

An ESPP is not the only instant raise that you can claim.  In my example above, I briefly mentioned 401k contributions.  Contribution to a 401K  and the company match should definitely be considered as it is often a 50% or 100% match on the first X$ of employee contributuion to 401K.  Afterall, while the ESPP plan gave me a 10% raise, the 401K match may be up to a 100% raise on that cash (If it will vest).  Maxing out your retirement contribution every year for the tax benefit is also worth considering.  Some companies offer health or dependent care FSAs or other benefits that may make sense as well based on personal and tax situations.

ESPP Arbitrage Final Thoughts

According to Fidelity, only 33% of employees eligible for ESPPs take advantage of them. While my company had offered a 10% match, many ESPPs are actually 15%! Getting a 15% raise is impactful. The key that I am trying to share with my ESPP hacking example is that taking advantage of your company’s ESPP could be a real opportunity.  While your company plan may look very different than mine did in this example, perhaps it could be used creatively to get a raise without having to even ask for it.  A 10% or with some company plans even 15% bonus is worth considering.

Is my ESPP Arbitrage strategy genius or foolish?  Do you have experience with an ESPP to share?  Please join the discussion in the comments section below.