Love My Company, Love The Stock? Beware Concentration Risk
Invest in what you know. It’s a common investing adage, and employees might think they know their employer better than anyone else. But should you invest in your company’s stock?
Owning a stake in the company you work for might have some advantages. You might feel optimistic about your employer’s future and wish to share in the wealth. As an employee, you may even be able to purchase stock at a discount. But there are risks you should consider.
One risk is under-diversification. It’s never smart to put too many of your eggs into one basket, and investors should always seek to have a diversified investment portfolio. That is especially true when it comes to investing in stock in your company, because when you invest in your own company, your finances are doubly exposed. In the event your company falters, not only might your investments tumble, but you might also find yourself out of work at the same time.
Just ask former employees of Enron, Lehman Brothers, and Radio Shack, who watched shares in their company plummet and were also shown the door.
“If the company fails or even goes through a hard time, your portfolio will take a hit at the time you're most likely to lose your job as well,” said Mike Piper, author the blog ObliviousInvestor.com. “That's a recipe for a financial disaster.”
Still want to own some shares in your own company? Read the answers to the following questions first.
How Might I End Up Owning Shares In My Own Company?
You might have an opportunity to buy shares in your company within your 401(k).
Or your 401(k) plan also might offer employer-matched contributions in the form of company stock or award you a bonus in the form of stock or stock options.
Some might set up a qualified employee stock purchase program (ESPP) that allows employees to purchase company stock, at a discount of up to 15 percent of the market price. The IRS limits employees from purchasing more than $25,000 a year worth of company stock within an ESPP.
If you receive company stock as part of your compensation or benefits, by all means, take advantage of the free stock. However, if you are compensated with stock or stock options, you should be particularly mindful of the need to diversify your portfolio. If you are compensated with shares annually, it might not be the best idea to then also allocate a percentage of your 401(k) to buying additional shares.
How Popular Is It To Own Company Shares These Days?
It’s become less common for employees to own stock in their 401(k)s today than it had been in the past. In the wake of the collapse of Enron, Lehman Brothers and Radio Shack, employers have moved to limit company stock ownership in 401(k)s.
Just 7 percent of 401(k) assets were invested in company stock at year-end 2014, according to a recent survey conducted by the Employee Benefit Research Institute and the Investment Company Institute. That’s a decline of 63 percent from 1999 when company stock accounted for 19 percent of 401(k) assets.
Even so, there have been recent examples of workers who plowed their retirement dollars into company stock only to see their investments take a beating. An analysis conducted by trade publication Pensions & Investments found that falling energy prices and sinking stock prices spurred notable declines in 2015 in the 401(k) plan assets of energy companies that offer company stock.
While workplace retirement plan assets invested in company stock have been declining, ESPPs appear to be growing in popularity. Sixteen percent of workers said their employee stock purchase plan is their most important benefit, up from 10 percent in 2014, according to a recent survey by Fidelity Investments, which administers employee stock purchase plans.
If I Own Ccompany Shares, Can I Sell Them When I Want?
Maybe not. Within your 401(k), your company might place restrictions on your ability to buy or sell the stock, or transfer it to another type of investment within your retirement plan.
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 might cause problems for you. 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 period (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.
Regardless, if you are subject to such restrictions, it’s just important to remain aware of what they are and to include them in your investment planning. That way you are read to hold on to the stock, or to reinvest it, as you see fit when such restrictions expire.
When it comes to qualified ESPPs, there are special tax rules associated with the timing of the sale of shares. It’s important to consult with a tax specialist to understand how these tax rules might impact your returns.
How Much Company Stock Is Too Much?
There is no one answer.
Some say one should strictly limit company share ownership. “Most people really shouldn't own any of their own employer's stock,” Piper said.
Others say it’s fine to own shares in your company, in moderation. Some experts recommend that no more than 10 percent of your portfolio be invested in company stock.
The bottom line: owning company stock may allow employees to share in the financial success of a company. But it also carries the risk that your employer's financial problems will become your financial problems. Be smart about the degree to which you are willing to tie your finances to a single company, even if its prospects look bright.
To read more about the dangers of owning too much of company stock in your 401(k), read FINRA’s Investor Alert.