Only a fool gets rich twice

Working in Silicon Valley and the tech industry for the last 15+ years I’ve become friends with a lot of people who have a very good problem: They have a life changing amount of money in a single stock.

My first experience watching people wrestle with this good problem was during the Twitter IPO in 2013. I joined just as the company had gone through a hyper-growth spurt and was getting ready to go public. I made a lot of friends who had been there for years and suddenly saw options and RSUs go from theoretical paper money to real tradable assets.

That November morning the office was packed even before the sun was up - everyone was excited and nervous. The stock was up 71% from the IPO price that day - people were ecstatic.

I was early in my career and had just sold a tiny startup to the social media company. When I went home that night and logged into my brokerage the RSU value displayed in my Schwab account after that first day of a trading was 20x more than I'd made in my entire short career.

In the following months I talked with many co-workers who went through scenario after scenario about how much to sell once the lockup expired.

In the decade following I saw the same drama play out over and over for friends as different companies went public or held tender offers. I saw first hand the greed and fear associated with high stakes decisions around life changing money.

Life Changing Money

How to define a life changing amount of money? There are two important factors:
A) How much is this single stock position worth relative to the rest of your investable assets?

B) How much is this single stock position worth relative to your annual spending needs?

What is a life changing amount of money for someone at the start of their career will matter almost not at all to an experienced founder or executive who has been through multiple large liquidity events.

If the position is, say, more than 50% of your investable assets and more than 10x you annual spending you're dealing with a life changing amount of money.

This comes with a lot of stress and uncertainty about what to do with that stock.

There are many people who sold too early and missed out on enormous wealth creation.

The industry is also full of people who were once incredibly wealthy on paper, and then lost it all.

I actually think the right decisions here are pretty simple (though not easy), but this domain is an absolute minefield of cognitive biases.

Biases

Anchoring: Over the last few years tech valuations have come down substantially - and many owners of stock are stuck anchored to the last high water-mark of their holding and their net worth. Conversely during a bull market holders of stocks see them rapidly rise and expect that trend to continue indefinitely.

Endowment: Owners of stock value that stock more highly than they would if they didn’t already own it - the very act of already having the stock in the account (and likely having an emotional connection to the company) causes them to increase the price they want for the stock.

Familiarity: Owners of the stock know more about this company than any other. Because they know more it makes them more confident in owning the stock. It likely makes them overconfident.

Risk Management

One of my favorite investing aphorisms is: Only a fool gets rich twice.

Once you have wealth you face a risk management problem. If you fail to manage risk you can go from rich to not rich very quickly.

Another favorite aphorism is this: The stock market is an escalator ride up and an elevator ride down.

Risk management must happen before you see storm clouds on the horizon. Prices can collapse or liquidity disappear the moment trouble shows up for either a single stock or a sector. You can't count on being able to make your way to the exit right when problems surface - by the time you see it so will everyone else.

Balancing greed and fear is the only way to perform well in an often volatile and uncertain market.

What to do

Sell something.

Generally the right decision lies somewhere between “sell nothing” and “sell everything” - which are two very obviously wrong decisions (at least to me).

Interestingly, though, I often talk to people who pick one of these two answers.

You have two underlying goals here:

A) Manage risk and truncate the distribution of possible outcomes to eliminate the really bad ones

B) Minimise regret from a scenario where the concentrated position goes down or up a lot

Critical to making the right decision here is an attitude of epistemic humility. You have to assume that you don't know what is going to happen. You can have a hunch or be bullish or bearish - and that can certainly tilt your decision making significantly on the scale between selling "everything" or "nothing" – but the best mindset is one that accepts the fundamental uncertainty of the future.

Generally I think most people when given a chance to sell a concentrated position should sell 20%-80%. More on how to choose within that range below.

How much to sell

The struggle I see people engaged in is that they have a life changing amount of money in a single stock - but worry that the amount of money could be even more life changing if it went up by 50%, 100%, 500%, etc.

The most useful framework for making decisions here is thinking in scenarios.

For example, often people neglect to think about the scenario where the stock simply goes to 0. For a really well run company with a strong balance sheet this may be extremely unlikely – but it happens. You can't ignore the possibility - especially at venture backed startups that have raised a lot of money.

Even if the company doesn't go to $0 the value of common stock or options could get severely wiped out. Many examples can be found but a recent iconic one is WeWork going from $47b to bankruptcy.

The hard part is that the stock you own today could go to 0 or it could go up 10x or 50x.

The reality is that every time you're faced with this decision there are strictly three possible outcomes. The asset will:

• Underperform/ go down
• Perform inline
• Outperform

The underperform or inline scenarios are easy to reason about - you'd have rather sold. The outperform scenario is what hounds people's imaginations filling them with fears of regrets.

Let's take a scenario that, for most people, would be a life changing situation - and make the numbers round and easy to deal with. Assume you've been incredibly fortunate and hold $10m in a single stock. Now assume you sell 50% – and then consider the scenarios where the price goes down 50%, stays flat, or goes up by 50%

The outcomes range now from having $7.5m to having $12.5m – where as if you didn't sell at all they'd range from $5m to $15m.

You're more worse off in the $5m scenario vs the $7.5m one than you are better off in the $15m scenario vs the $12.5m one – despite them both representing at difference of $2.5m.

This seems elementary when you consider that at $5m adding $2.5m would be a 50% boost to wealth and at $12.5m it would be a 20% boost.

This is because of the declining marginal utility of money – Remember this graph from levels and derivatives:

So it's exactly the upside scenario - where if you didn't sell you now are much richer and even more overweight the single asset where you should be fine to own less of it.

The problem is that you can't know what the future will hold so you have to think through the scenarios ahead of time.

If you're insanely bullish on a stock and think it's going up 5x in the next 4 years - that's GREAT. Sell the amount of stock today that deliver the number of personal wealth you want to hit in 4 years assuming the stock goes up by 5x.

So, let's say our theoretical person wants to have $25m. They have $10m now. Ignoring taxes for the moment to make this simple, this means they should sell $6m in stock today because they expect the remaining $4m to grow by a factor of 5 and become $20m.

Selling over time

Thus far in this post there's a bit of a (false) assumption that you need to make your decision all at once. For a lot of startup employees they have a big event - either a tender offer or IPO where they can sell for the the first time - but often this is not the last opportunity to sell either.

There is both an important decision as to what to do with that first event - and a thought process about how to think about subsequent events.

Let's say your $10m position represents a 10bps ownership of a $10b company today, and you're really bullish. You think the company can become $100b in the next 10 years - that's a ~25% annual growth rate which is way above the market rate and could yield you a fortune of $100m if you wait 10 years to sell.

Here, again, we face two major problems:

a) You don't want to wait 10 years to use this money, heck in 10 years you could be dead - life is uncertain.

b) The company could underperform, perhaps catastrophically, over 10 years

The way I think about solving this is setting up a pre-commitment to sell a proportion of your holding steadily over a 10 year period. This pre-commitment could have various kinds of triggers, e.g.

• Sell a certain number of shares each year, regardless of the value
• Sell a proportion of the value of the holding (say, 50%) that is above some dollar figure. e.g. sell half the value each year that rises above $5m
• Sell a proportion of the value of the holding that rises above a target percentage of your net worth e.g. sell down the position such that it's only 20% or less of your balance sheet regardless of what the stock does

You can also combine these: e.g. every year I sell 25,000 shares - and I'll sell 50% of any remaining holding that is over 20% of my net worth.

These sort of plans have a favourable characteristic that if the company continues to outperform over time you continue to benefit from the growth while continuously taking risk off the table.

You can build a simple Sheets/Excel model here and play with what happens as the company increases or decreases in value. I think there's no substitute for doing a simple model to really see/feel the numbers.

Selling over time in this way with a pre-committed plan helps you avoid getting swayed by moments of fear or greed. It also helps manage tax liability since if you take a longer time to sell you can harvest losses to offset gains and/or spread the income tax liability out over multiple years.

Objections

Generally most objections here have to do with "but I could have had more money" in the upside scenario, like this:

Objection: Sure but if it goes up 5x I could have had $50m! That's twice as much as $25m

Answer: Sure, but you also could have ended up with $0 or $3m. The downside protection is worth a lot because money is worth a lot more to you when you have $3m than when you have $30m

The declining utility of more money means that maximising expected wealth is the wrong framework. You want to minimise regret.

If you sell over time and the company hits the target you thought they could ($100b) - yes you'll have foregone the $100m personal outcome - but you may be able to construct a plan with way less risk that still gets you to, say, $50m. Because of the decreasing utility of money $100m is worth less than twice as much as $50m to you.

Edge case: Founders

For the vast majority of people who are in this situation they’re employees or investors who should be making entirely portfolio oriented decisions. For a small subset involved - founders or extremely senior executives - their ownership may be an important part of their identity and a signaling factor.

Mark Zuckerberg shouldn’t be making normal portfolio allocation decisions about Meta stock both because he’s so wealthy "normal" portfolio thinking doesn't apply to him – and because his role as the founder-owner-operator helps bolster faith in the company and provides him control.

I think the way founders probably want to think about this is fundamentally different than others - likely thinking about selling a dollar amount that they need to be set for life or be able to support lifestyle needs - rather than as a percentage of their net worth they’re targeting in a single investment.

Conclusion

Another investment industry aphorism that I love is: Pigs get slaughtered. You have to keep your fear and greed in balance.

Too much fear and you'll get crushed by regret and inflation. Too much greed and volatility and losses will eat your portfolio and your sanity.

The allocator mindset is one where you have a distribution of bets such that while some potential future market situations will be better or worse – the vast majority of potential outcomes will be tolerable.

Most people are never fortunate enough to accumulate a large asset base. Only a fool gets rich twice - manage your risk.