Work for a company that pays part of your salary in stock? Beware of this trap

For many people, compensation is limited to a weekly, bi-weekly, monthly, or other rhythmic paycheck into a bank account. But if you work for a publicly traded company, you may receive a combination of cash and company stock as a reward.

This is not necessarily a bad way to get paid. When you receive a $100,000 paycheck, you get $100,000. If $80,000 of your paycheck is in cash and the remaining $20,000 is in stock, then over time the value of that $20,000 in stock could grow to $25,000, $30,000 or more.

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On the other hand, where you are paid in shares, there is a risk that your shares will depreciate over time. Therefore, you are taking a risk here, which may be a very obvious disadvantage of this type of compensation. However, receiving rewards in the form of shares can also backfire for a less obvious reason.

Where your portfolio is no longer diversified

You'll often hear that it's important to keep your portfolio diversified, because not only does it allow your investments to grow steadily over the long term, but it also protects you from excessive losses. The problem with paying in shares, however, is that if you keep accumulating shares in the same company, eventually they may become a large part of your portfolio.

This could lead to a huge imbalance. Moreover, if the prices of these stocks were to plummet, this would also cause problems.

Let's say you receive 10 shares of Company X each month as part of your return. At first, these 10, 20, or 30 shares may only account for 3% or 4% of your Brokerage Account's investment name, but over time, as you continue to collect these shares, they may eventually account for 20%, 30%, or 50% of your investment name.

At the same time, suppose that the total value of your stock portfolio eventually grows to $100,000. If you have 50% or $50,000 invested in Company X, and its share price drops by 20%, then you have only lost $90,000, or $10,000, in the value of your portfolio. That's a pretty big drop. If Company X accounts for only 10% of your investment name, or $10,000, then a drop of 20% in its share price would result in a loss of $2,000 in the total amount of your investment name.

How to maintain a well-balanced portfolio when paying salary in shares

If you have worked for many years for a company that pays part of your salary in stock, you may eventually accumulate a large amount of stock. Therefore, what you need to do is find out what percentage of a single stock is too high for your taste and develop a stock unloading plan accordingly.

Some people may accept that a single stock represents 20% of their portfolio, while others may prefer to limit this to 5% or 10%.

Once you have found the right number for yourself, you can begin to sell your shares after holding them for at least one year and one day in your share portfolio. In this way, you will be able to tax your profits as long-term capital gains, rather than short-term gains, which apply to investments held for a year or less. The long-term capital gains tax is more favorable, meaning you'll pay less tax on your profits to the IRS.

It is often the case that capital gains tax only becomes an issue when you sell your stock at a profit. But ideally, that's exactly what you do.

It is not uncommon for a person to be paid partly in cash and partly in shares. However, in such cases, it is important to manage your investments accordingly to avoid problems caused by an imbalance in your investment portfolio. If you decide to start selling some of your company's shares, make sure you do so at the right time in order to minimize your tax loss.

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Work for a company that pays part of your salary in stock? Beware the Trap was originally published by The Motley Fool.