- January 29, 2021
It’s that time of year again! The time of year when you get to decide the mix between Stock Options and Restricted Stock Units (RSUs) you receive for your Long-Term Incentive Plan (LTIP). While this has been an annual rite since 2014, the decision is no less important for you now than it was the first time. Your financial situation may have changed since then. You may have different goals now. You may even be making this election for the first time.
Your LTIP is an important component of your total compensation as a 3Mer. If properly evaluated and selected, it can be a valuable tool to help you meet short-term needs and generate long-term wealth. How you approach this decision should reflect its importance.
A thoughtful decision involves three components. One, a careful evaluation of your financial situation and goals. Two, an understanding of the trade-offs between Stock Options and RSUs and how each can best help achieve different goals. And three, reasonable expectations of 3M stock based on its history. Of course, it’s impossible to know with certainty what future outcomes will be but following a consistent process will increase your odds of optimizing your LTIP based on your needs.
Making your election is only the beginning. After three years, your awards will vest. RSUs will become unrestricted shares of 3M stock and Stock Options will be available to exercise. You will have multiple decision points along the way and your situation and goals may even change – particularly over the entire 10-year life of Stock Options. It is important to keep goals in mind as the share price can often move significantly during the life of your RSUs and Stock Options.
What follows is a process and framework for understanding the benefits and risks of Stock Options and RSUs, how to decide how to receive your LTIP award, and how to evaluate handling vested RSUs and exercising Stock Options.
Be sure to read on to where we discuss real-life situations you’re likely to encounter when considering your choices among RSUs or Stock Options, as these may be particularly helpful.
Your decision on how to receive your LTIP is an important first step that you want to get right. Below is a summary of the key elements to help you understand this choice. For a comprehensive guide to making this election decision, download our full analysis here.
Restricted Stock versus Stock Options
There are many technical differences between these two types of share structures (see Appendix in full analysis here for detail). But there is one key distinction that will be a foundation for building upon what follows.
RSUs provide relative certainty of value over the short-term. Stock Options create potential value over the long-term.
Some examples where the traits of RSUs may prove valuable include:
- If you plan to pay college tuition for your daughter or son beginning in three years, RSUs can help supplement college savings and provide peace of mind that you won’t need to use salary or AIP to supplement.
- If you are planning to build or buy a new or additional home, cabin, or condo in the next few years, RSUs can help you accumulate cash for your down payment.
Some examples where the traits of Stock Options may prove valuable include:
- If you plan to pay college tuition for your daughter or son, but they don’t start college for many years you can wait for the higher potential payoff from Stock Options.
- If you are planning for a new home or cabin farther out in the future, or are flexible on the timing of this goal, waiting for the potential of Stock Options may provide more than the minimum down payment. It can also reduce the amount of a mortgage or how much you need to draw from your portfolio.
- If you have been receiving LTIP for several years and have multiple RSU or Stock Option awards that have or will have value for shorter-term needs, you have more flexibility to select Stock Options for your subsequent awards.
How do you decide?
The most important question to ask before deciding on your LTIP mix is, “Do I have spending goals or obligations in the next 3 to 5 years that depend upon my LTIP?” If the answer is “yes,” then it is wise to include some RSUs in your mix. An answer of “no” indicates you have the ability to wait for stock options to reach their potential and may not have a need for RSUs. However in this case, having some RSUs in your mix may actually make it easier for you to wait for Stock Options to realize their potential.
Take a look at some concrete examples of this decision in action with stories of Roger, Anna, and Tom in our full analysis. Download it here.
A few key themes about LTIP mix selection may be evident in our short stories about Roger, Anna, and Tom.
- Evaluation of your choice for LTIP mix must consider the entirety of your financial plan, goals, and resources rather than only the merits or risks associated with RSUs or Stock Options. Evaluating your mix based only on expectations about RSUs or Stock Options may lead to unrealistic expectations about their benefits and open up the potential for regret if expectations aren’t met.
- We have observed that as most recipients of LTIP advance through their life and career, there are more short and intermediate term goals to check off the list. Setting up your LTIP to help with this can help keep your long-term investment portfolio focused on the long-term. Your LTIP mix can evolve with you as your goals and resources change over time.
- Our behavioral biases cannot be ignored. Specifically, in the case of Anna, objectively she could select only Stock Options for her LTIP. However, if she knows or believes that she can be more patient in waiting for Stock Options to reach their potential with the “hedge” provided by RSUs, then it is wise for her to consider adding 25% RSUs to her mix.
You have an important decision in front of you in how you elect your LTIP mix. If evaluated and chosen properly, these awards can and will be valuable tools for your financial success. Keeping your goals in mind when making your choice is an important first step in optimizing your LTIP.
There will be more choices along the way. Awards will vest, the price of 3M stock will fluctuate, and you will need to sell RSUs and/or exercise Stock Options. Even if your goals change along the way, they provide the best foundation for the decisions you encounter while owning your LTIP awards.
To help clarify your election decision further, please take a look at our full analysis of optimizing your LTIP, found here. We think this will be a valuable tool for getting this decision right.