Putting Too Much Stock in Your Company—A 401(k) Problem
Although major Enron and Worldcom trials have long since concluded, stories of employees risking the loss of some or all their retirement income remain in the news. Now is a good time to ask yourself if you hold too much of your retirement nest egg in your employer's stock.
We are issuing this Alert out of a concern that employees who have the opportunity to invest in company stock may be concentrating too much of their retirement savings in a single security. Of particular concern are employees who have all or most of their 401(k) assets in their employer's stock. If the stock takes a beating, so does your retirement savings.
No Restrictions Can Lead to High-Risk Investing
Currently, there are no restrictions on the amount of 401(k) assets that can be held in company stock. While the Employee Retirement Income Security Act of 1974 (ERISA), restricts traditional pension plans (also known as defined benefit plans) from investing more than 10 percent of assets in company stock, there is no similar restriction on 401(k) plans.
Employees can direct a high percentage of their contributions to company stock, even if they are given other investment options. Employer-matched contributions often come in the form of company stock, further concentrating holdings in employer stock. A study by the Employee Benefits Research Institute and the Investment Company Institute found that 53 percent of employees who have the opportunity to invest in their company's stock do so. Nearly 7 percent have more than 80 percent of their 401(k) assets invested in their employer's stock. In the case of employees in their sixties, almost 15 percent hold more than half their 401(k) savings in their company's stock, compared to 19 percent the year before, and almost 8 percent have more than 90 percent in their employer's stock, compared to 11 percent in 2008. The result: a non-diversified retirement portfolio that hinges to a large extent on the performance of a single stock.
Learning from History?
The fall of Enron Corporation focused attention on the potentially devastating effect of owning too much company stock. 57.73 percent of employees' 401(k) assets were invested in Enron stock as it fell 98.8 percent in value during 2001. But employees at many companies still have even larger percentages of their 401(k) assets in company stock than Enron employees did.
What Could Go Wrong If You Concentrate Retirement Savings in Company Stock?
Simply stated, if you put too many eggs in one basket, you can expose yourself to significant risk.
In financial terms, you are under-diversified: you have too much of your holdings tied to a single investment—your company's stock. Investing heavily in company stock may seem like a good thing when your company and its stock are doing well. But many companies experience fluctuations in both operational performance and stock price. Not only do you expose yourself to the risk that the stock market as a whole could flounder, but you take on a lot of company risk, the risk that an individual firm—your company—will falter or fail.
Restrictions Can Limit Liquidity
There's another potential problem with concentrating too much of your savings in company stock. Your company may place restrictions on your ability to buy or sell the stock, or transfer it to another type of investment within your 401(k). This limits the control you have on your finances.
Employer-matched stock, in particular, often comes with restrictions. Some companies require employees to hold the stock until they reach a certain age, or until a specified date. This can spell trouble. If the stock slides, you may be stuck on the sidelines without the ability to sell and limit your losses.
Lockdowns or blackouts can also occur. These are periods in which account activity is frozen, generally to perform administrative tasks. Usually lockdowns are for a short duration (a few days to a few weeks), with employees given advance notice. Nonetheless, it's possible that a lockdown could coincide with a slide in company stock. This happened at Enron, when the stock declined more than 35 percent during a pre-scheduled two-week blackout.
How Much is Too Much?
The general consensus among financial experts is that an adequately diversified portfolio should have no more than 10 to 20 percent of total investment assets in company stock. If you concentrate much more than that in company stock, especially in a 401(k) plan where there are trading restrictions, you may expose yourself to more company risk that it is wise to incur. Of course, there is no single formula or percentage that suits all investors, so you should consult a professional about what the right mix of investments is for you.
If you are one of the 9.7 million participants in 401(k) plans that offer company stock and you have more than 20 percent of your assets in company stock, and this investment also constitutes more than 20 percent of your overall investment portfolio, you may want to consider re-balancing your investments to increase diversification.
What is Diversification?
Diversification is an investment strategy for spreading your principal among different markets, sectors, industries, and securities. The goal is to protect the value of your overall portfolio in case a single security or market sector takes a serious downturn and drops in price. In short, diversification spreads your risk, while still seeking a strong return on overall investment. FINRA's Smart 401(k) Investing learning center has additional information about diversification and rebalancing your portfolio.
Take Control of Your Financial Future
To achieve appropriate diversification, employees with company stock should consider doing the following:
It's Your Retirement
Owning company stock does allow employees to share in the financial success of a company. But it also carries the risk that a company's financial problems will become the employee's financial problems. When it comes to investing for retirement, it's you, not your employer, whose financial security ultimately is at risk from overexposure to company stock.
In determining how much you should invest in company stock remember that your retirement is just that—yours!
For additional information on saving for retirement, read Smart 401(k) Investing.
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