A version of this article was originally written for and published on Kiplinger.

Equity compensation can be an extremely useful tool when it comes to building wealth. And just like any other tool you may use, you can leverage your equity comp to build something great — in this case, significant wealth — or, you can mishandle it and end up with a poor outcome.

One of the biggest considerations that most people who have equity comp (including stock options, RSUs, or the ability to participate in ESPPs) overlook is concentration risk. This is a critical aspect to understand if you want to use your equity comp as a tool to build your wealth… and avoid letting it put your net worth at risk.

Equity Comp Can Overexpose You to Concentration Risk

Anytime you hold a large amount of a single stock position, you increase your concentration risk and therefore the overall risk inherent in your investment portfolio.

This can become especially problematic if you hold a lot of stock from a single company that also happens to pay your salary.

As a general rule of thumb, I suggest that my clients keep their exposure to any single stock position to no more than 5 percent of their liquid net worth.

Unfortunately, people with equity comp struggle to stick to this rule for a number of reasons that range from feeling loyal to their company to simply failing to understand that regardless of how they feel about concentration risk, they can’t afford to take it.

To help you take on the right amount of risk (concentrated or otherwise), here’s what you need to think through if you receive equity comp as an employee benefit through your company.

Whether You Hold Company Shares or Not Shouldn’t Be About the Company Itself

When it comes to properly managing equity compensation (or any single stock position, for that matter), it’s often tough to separate short-term circumstances from the bigger, broader, long-term perspective.

But that work is critical to do so that you can make decisions that make sense in the context of your entire financial plan. That means you have to think through the choices with this specific aspect of your finances that will allow for the best probability to grow — and maintain — your entire net worth and investment portfolio as a whole.

When I advise my clients to reduce the exposure they have to their company stock through equity compensation, that recommendation has little to do with their company itself or whatever current events are going on around us, and everything to do with concentration risk.

That’s often hard to hear or understand, because clients often feel loyal to their employers. They may feel shedding company stock is a betrayal of a business they feel passionately about.

Or, because they do work for the company, from their perspective the value can only go up because things are going great. They have an inside view, after all, and they might feel extremely positive about where the business is headed.

And that might be true; your company could very well be posed to explode in growth and therefore value, which could cause stock prices to rise (and you to benefit if you happen to hold a significant amount of shares).

There is no denying that equity compensation is one way to exponentially grow wealth. And yet…

When you have a significant amount of money tied up in one company, putting your feelings over your financial plan is a massive risk to take.

Here’s the bottom line that most people miss in this debate:

There is a difference between “generating the most money possible” and “generating the level of wealth you need to reach your stated goals and desires.”

The difference is the risk you take.

When You Can’t Actually Afford to Take Risks (Even If You’re Emotionally Able to Handle It)

Generating the most money possible requires that you take more risks than generating a sufficient amount of wealth to meet your goals and live the way you want. 

Knowing how much is enough is a critical component in any financial plan.

Taking on more risk is fine if losing your money, rather than experiencing gains, is something you can afford to do.

In this case, “afford” means losing what you have tied up in the riskier position and having enough wealth elsewhere that the loss does not affect your ability to meet your goals and live the way you want

So ask yourself: if you lost the investment you had in your company through a concentrated position created by your equity compensation — and potentially your income along with it — would it be a severe blow to your ability to reach your goals and afford your lifestyle now and in the future?

Remember too that there is a difference between risk tolerance, or how you feel about risk, and risk capacity, or your actual ability to take risks without putting yourself in a position from which you cannot recover.

When you find yourself in a situation where the downside risk could devastate your ability to be financially successful, it doesn’t matter how you feel about the investment.

It’s a bit of a moot point about how well it could do because it’s not something you can afford to do, if you cannot adequately recover from realizing a loss. 

A Real Life Example of the Downside of Equity Comp and Concentration Risk: The Case of Uber

This isn’t just hypothetical. This can and does happen in the real world, and we just witnessed it with Uber in the spring of 2020.

Because of the COVID-19 pandemic, stock prices dropped and Uber laid off thousands of workers. If the employees with equity compensation packages were included in those layoffs, they just lost their incomes and a lot of investment portfolio value.

If this happened to you, how financially devastated would you be by this outcome?

This is just one example — and that’s not to say this is what will happen to everyone who has equity compensation and holds more than 5 percent of their liquid net worth in their employer’s stock.

We have no idea how individual company performance will be in the future, for better or worse.

And that is exactly why the focus on diversification is so important, because it protects against an unknown and the a risk that you couldn’t truly afford to take if the loss of both your income and a huge portion of your net worth would mean not being able to meet your short- or long-term goals. 

Keep the Focus on Your Goals, Not the Hopes of a Home Run via Your Equity Comp

None of this is to say equity compensation is a bad thing — it certainly isn’t! It’s truly a great opportunity for you as an employee to add to your wealth-building firepower.

But you must understand how to manage this benefit wisely.

That’s the takeaway here: receiving equity comp is not a guaranteed, one-way ticket to wealth. Even though it can present you with an amazing opportunity, you still need to think critically about how your stock options or RSUs or ESPP fits into your overall finanical plan.

For most people, that means keeping a careful eye on the concentration risk equity comp it can introduce into your portfolio if you begin building up large amounts of a single stock (especially when that single stock is tied to the company that also writes your paychecks).

If your goal is to increase your probability of a successful outcome — which, for most people, means having money for your long-term goals and an ability to fund your lifestyle without running out of money in your lifetime — then seek to set up a systematic, unemotional investment plan that divests from concentrated stock positions and into a diversified portfolio.

While the potential for home runs and having your company be the next Apple is a much sexier-sounding strategy, it might not be one that is best for you to pursue.

Even if a diversified portfolio ended up providing you with less money than holding stock in your company if it exponentially increased in value over time, that’s OK… and that’s probably the hardest thing to understand about all of this.

Remember, the point is not to end up with the most money possible. You don’t need your investment portfolio to consistently outperform.

What you need is a reliable way to earn enough of a return to achieve your goals without taking on excessive risk. In this case, excessive risk is the downside potential of a company doing poorly, trailing returns of a diversified portfolio, or failing altogether.

Managing risk isn’t always the sexiest, flashiest, most exciting part for building wealth… and yet, if you don’t consider risks, there might not be any “building wealth” for you at all!

Keeping concentration risk in mind if you have equity comp is critical because it helps you avoid risks that you can’t actually afford to take, or recover from — and, while maybe not super sexy, it certainly is a smart way to ensure you’re financially successful over time.