Saving as you Earn – How quaint
If you work for a larger company you might be given the chance to participate in a Save As You Earn (“SAYE”) scheme.
You’d be offered the opportunity to plump for somewhere between £5 and £500 a month for the next 3 or 5 years (or maybe even 7). Then you could use the accumulated funds to buy stock in the company at a fixed option price. Ermine has a nice post on the subject that’s worth a read.
Your risk averse muscles may start twitching at this and rightly so, give them a pat. In order to see any of the potential gains you have to lock up your hard earned cash for years. Not only that, you are tied to the company for those years as well. If you leave, you leave the options behind. There’s nothing to stop you leaving and taking the cash with you, but you lose any right to the options.
So that’s potentially £500 a month that is otherwise unavailable to invest elsewhere and a drag on you should you wish to move jobs.
If you do stay the term you could be left with a substantial pot of cash to use on options.
The scheme will offer you the option to purchase shares at some point in the future at a fixed price. The point in the future is fixed at the outset, somewhere between 3 and 5 years, as is the option price.
An option gives you the choice to purchase shares at a fixed point in the future, but importantly not the obligation to. So the power is in your greedy wee hands.
The option price
At the start of the scheme the company will set the option price based on the companies current share price. This is fixed from the start of the contract and represents the price that you can buy shares for at the end of the scheme.
The real kicker comes in the form of a potential discount, the company can offer you the options with up to a 20% discount to the market value.
Let’s say you are working for Dream Smasher Plc, which has a current share price of 100p. They offer you the chance to enter into a 3 year SAYE scheme, with the full 20% discount. So you’ll have an option price of 80p. Feeling bullish, you opt for the full £500 a month. Where does this leave you in 3 years time?
Contributions into scheme – £500 x 12 x 3 = £18,000
At the end of the three years you will be asked whether or not you want to exercise the options, i.e. use your £18,000 to buy shares at the option price or not. This will all depend on what the share price has done in the mean time.
Share price at 70p – below our option price of 80p
Your options would be worth £18,000 x (70/80) = £15,750.
Cash is worth £18,000.
Because the option price is less than the current market value you would lose £2,250. If you really wanted the shares you would be better just taking the £18,000 in cash and buying shares at 70p, rather than the option price of 80p.
Share price at 90p – between our option price of 80p and the initial MV of 100p
Options would be worth £18,000 x (90/80) = £20,250.
Cash is worth £18,000.
So even though the share price has tanked a little bit over the three years, you would still have made a gain of £2,250. Good work.
Share price at 115p – in excess of both the option price of 80p and initial MV of 100p
Options would be worth £18,000 x (115/80) = £25,875
Cash is worth £18,000
Taking the options here would get you a nice gain of £7,875. Much in excess if we had bought the shares at 100p, for a gain of £2,700.
That is a gain of £7,875 / £18,000 = 43.75%, or 12.86% annualised, right? Well, not quite, because not all of the £18,000 was invested at the start of the scheme. Only the first £500 has been invested for 3 years, the rest for less, with the last only being invested for a month.
It actually works out as just under a 25% annual return for an increase of 15% in the MV of the share! Holy shitballs, not bad. The reason it works out so high is due to the later months. Looking at the last month we are investing £500 to buy options at 80p. In a months time we can use this £500 to buy shares worth 115p, for only 80p. In a month the £500 grows to nearly £720. So a gain of nearly 44% in the month, which annualised is in excess of 7,500% ( approx [1.44^12]-1). W00t.
Now, this might appear as playing about with numbers, for numbers sake. And indeed the gain in the last month is meaningless really, as you need to look at the scheme as a whole. But it does provide some indication of how powerful these schemes can be.
Power to the Option
Power of the option in my crusty undead eyes;
1 – optionality itself. It let’s you invest in a company, without the fear of the market value dropping. If it comes to the end of the term and the market value has tanked, no big deal, you just take the cash. Admittedly you might have lost out on gains else where, but not as much as you would have investing in the company shares from the start.
2 – the discount. Even if the shares drop a little you can still make money if it’s above the option price. If the stock price does increase in value then you stand to make even more.
3 – tax benefits. Your scheme may offer you a small tax free bonus on your cash at the end of the term, but it’s not likely to be significant. The bonus on mine is around 1%. The income on exercising the options is not subject to National Insurance or income tax, which is nice. The Capital Gains Tax get’s a little confusing, but I think if you transfer it straight into ISA you won’t be liable for that portion, Equiniti seem to think that’s possible. You’d have to do pretty well to breach the CGT limit, but still worth thinking about. SAYE is deducted monthly from your salary, sadly after tax.
Drawbacks of the option
The suspicious Zombie always considers the drawbacks as well;
1 – you and your money are tied up. Your money is locked-up for the period that the scheme runs for, if you want the options at the end of it. This can make you feel tied to that company, and perhaps even delay moving job. So this is your job and a substantial amount of savings being tied into the fate of one company. Nice diversification there, buddy.
2 – tax efficiency – it’s not the most tax efficient way to save. If you are saving the £500 a month you are almost certainly going to breach the ISA limit at the end of the term. And if you are a saving martyr then you are probably maxing out your ISA allowance on top of this anyway. But there is the potential for the gain to be in excess of tax inefficiencies.
How to include in your Net Worth
I reckon there are three ways to include the options from a SAYE scheme in your Net Worth.
Include at the value of the share price, with a floor set at the option price
This way we are reflecting the value as if we could exercise the option now, but recognising if the price drops below the option price we would take the cash.
Include as cash plus an option valuation
If we were so include we could value the option, typically using some closed formula approach like Black-Scholes. But this would involve estimating the volatility of the under-lying share and it could get a bit messy.
Cash plus the option valuation would be added to Net Worth.
Interesting, if you have the time.
Include as cash
The simplest and most prudent approach. Admittedly this will result in a step up in your Net Worth should you exercise the options.
What to do
I just include the cash value of mine, mainly out of laziness.
I have been meaning to add an option valuation to see what it would look like, but it would probably just add more volatility to my New Worth. Besides, Zoopla seems highly capable of adding all the volatility I need in my property value.
Are they worth it?
As your only form of saving, it seems fairly risky. It’s easy to get blinded by the potential gains. At the end of the day it is dependent upon the performance of one share price, and that’s it. Contributing to a pension/ISA in the first place, in a diversified way, should be a prerequisite in my opinion.
I’ve lumped up for the full £500 a month into mine, into two different SAYE schemes. At the moment they are both showing some sexy gains.
I’m happy with the SAYE scheme, as I’m lucky enough to be in profit. And after they mature I would probably stump up for another term, perhaps not for the full £500 though. I imagine I will time it just as a crash is around the corner.
Any thoughts on these schemes?
[And if you’re thinking about investing in your companies SAYE scheme, get some advice. Don’t take a guy who pretends to be a zombie’s advice. Common sense, right]