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Avoid a Company Stock Meltdown in Your 401(k)
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By Clifton Linton
Senior Writer, mPower |
It took only one word for Certified Financial Planner
Gay Abarbanell to finally win a running battle with one of her clients over his large
holdings of his employer's stock: "Enron."
"I told him his company could be the next Enron,"
Abarbanell said. His reply: "Ouch!"
The client sold some shares by the time his own company's
share prices tumbled. But he didn't sell enough -- his investment in company stock, once
one-third of his net worth, is now one-thirtieth.
"I felt bad that I was not persuasive enough for him
not to learn (this lesson) the hard way," said Abarbanell, a planner with National
Planning Corp. in Culver City, Calif.
As the bear market of 2001-2002 continues to eat away at
401(k) balances, many other workers are also learning hard lessons about having too much
of their retirement assets in company stock. Below are some strategies to mitigate or
minimize the impact of company stock on your portfolio.
Emotional Investments
Company stock is not like most other investments. It can be
difficult to separate yourself from the emotions involved. You work at the company,
meaning you stake your career on the place. You want to share in your employer's good
fortune. And upper management may pressure employees to own stock for several reasons: the
company gets a tax break, it wants stock to be held in friendly hands to avert hostile
takeovers, and many believe company stock ownership bolsters employee loyalty.
The attachment folks have to company stock is almost like
love, said Richard Stoyeck, chairman of StocksAtBottom.com, a Web-based subscription
service providing information and commentary on stocks and the market.
"It is very difficult to talk to people in love. They
don't want to hear rational thoughts until things go against them," he said.
It can be easy for 401(k) savers inadvertently to allow
company stock to dominate their portfolios. Many employers make matching contributions
with company stock. It may be offered as an investment option for an employee's
discretionary contributions. Your company's shares may be held by the mutual funds you
invest in. With many employers also offering Employee Stock Ownership Programs (ESOP) and
stock options, it's not hard to build up a large position.
"For some people it becomes their entire
savings," said Edward Stavetski, director of equity research at Pitcairn Trust in
Jenkintown, Pa.
Large company-stock holdings can increase your portfolio's
volatility. "Most individual securities are more volatile than the market as a whole,
and all stocks are subject to additional risk stemming from specific company news or
related industry issues," said David Goerz, chief investment officer with mPower
Advisors, L.L.C. mPower is a registered investment advisor that provides investment advice
to retirement plan participants and publishes this site.
Company stock "shouldn't dominate" your
portfolio, Goerz added. mPower recommends to its clients that they reduce their company
stock holdings as much as is practical and allowed by their 401(k) plan rules, in favor of
more diversified investments.
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| "We need to take the emotion out
of the investment decision." |
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| Hoyte Pyle, investment manager and
chartered financial analyst (CFA) with Bank of the Ozarks Trust Management in Little Rock,
Ark. |
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How much company stock is too much? That depends on how
your other investments and assets are allocated. While some advisors say you shouldn't
invest any retirement savings in a single stock, others suggest that company stock
holdings above 10 percent of your portfolio's net worth should raise a red flag.
Hoyte Pyle, investment manager and chartered financial
analyst with Bank of the Ozarks Trust Management in Little Rock, Ark., said when clients
give his firm total discretion over investment decisions, he liquidates company stock
holdings. "We need to take the emotion out of the investment decision," he said.
Company Stock Strategies
To keep a more rational approach to investing, here are
some suggestions for dealing with company stock.
1) Figure out your total holdings of your employer's
stock. Create a personal balance sheet listing all your assets and liabilities.
Include the specific investments in your 401(k)s, IRAs, bank and savings accounts and
brokerage accounts. Look at the prospectuses of your mutual funds to see whether they own
shares in your company.
2) Assess your investment risk tolerance. The more
you hold of a single stock, the more volatile your portfolio is likely to be. This
volatility is what we mean by investment risk. Comparatively, the risk many novice
investors fear is losing their principal. In most cases that's unreasonable. Unlike a
casino bet where you can lose your entire stake on a single roll of the dice, when you
purchase securities or mutual funds there's a good probability that the company or
companies will survive almost any catastrophe and pay some kind of return.
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| "If your employer is an important
investment, you owe it to yourself to learn about your company." |
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| Karen Spero, a CFP with Spero Smith
Investment Advisors Inc., of Cleveland, Ohio |
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In assessing your risk tolerance, consider factors such as
your time horizon and retirement goals, whether you have the money to take risk, and
whether you feel comfortable taking risk.
Savers with long time horizons can afford to take on more
investment risk because their investments will have more time to recover from potential
losses. Remember, you can't make money without taking some risks. It's a matter of knowing
your own comfort level.
3) Create a diversified portfolio based on your risk
tolerance. By spreading your money among various investment asset classes you accept a
compromise, giving up potential high returns and high portfolio volatility in exchange for
consistent returns with lower volatility.
You want to divide your money among investments that don't
move in synch with each other, such as cash, bonds and stocks. That way, if one asset has
a rough time, the others may support the portfolio. Mutual funds are diversified in that
they contain a number of different issues, but these are often within a single asset
class. You may need to invest in several mutual funds for adequate diversification, unless
your plan offers a "balanced" or "lifestyle" fund that is more of a
one-size-fits-all solution.
If you do hold company stock in your 401(k), you can
mitigate that risk by using discretionary funds inside and outside your retirement plan to
purchase other assets, recommends Karen Spero, a CFP with Spero Smith Investment Advisors
Inc., of Cleveland, Ohio.
4) Be dispassionate about your company stock. This
may be hard to do. But, you should scrutinize company stock like any other investment,
Spero said.
Most folks feel comfortable investing in company stock
because they think they have an inside track on information about their employer. However,
"most people don't know it as well as they think they do," Spero said.
"Regularly check the financials. If your employer is an important investment, you owe
it to yourself to learn about your company."
5) Rebalance regularly. What many workers don't
realize is that they need to regularly rebalance their 401(k) portfolios to stay within
their risk level and to protect against potentially huge losses. Rebalancing is when you
sell or buy funds in your plan so that your asset allocation percentages remain consistent
-- among other things, this enables you to keep to a reasonable level of company stock in
your portfolio. This should be done at least once a year.
If you worked for a company whose stock did particularly
well during the 1990s and you received an employer matching contribution in stock, you may
have extensive company stock holdings. In this case, you should be particularly vigilant
in rebalancing your portfolio regularly to regulate the amount of company stock and stock
in general, said Goerz.
6) Limit future purchases. If your employer makes
its matching contribution in company stock, don't turn it down, said Goerz. "The
benefit of the company match is compelling and underutilized by most employees," he
said. "Every participant should take full advantage of company matching programs, but
it is not necessary to commit additional assets to company stock."
You might be prohibited from selling the company stock in
your plan, but you don't have to buy any more with your own contributions to the
plan or in investments outside the plan.
If you have large company-stock holdings, you may consider
developing a hedging strategy with exchange-traded stock options, Spero said. But, this
type of strategy is sophisticated and costly, and requires the assistance of an investment
professional.
Legislative Relief?
Congress is looking into the company stock issue, and
President Bush has even weighed in with 401(k) reform proposals. It's possible that some
legislation may eventually pass placing limits or restrictions on company stock held in
401(k) plans.
But this could take time, and investors shouldn't wait. If
you're concerned about company stock in your 401(k) plan, use our guidelines to assess and
act on your own situation.
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The information provided here is intended to help you understand the general issue and
does not constitute any tax, investment or legal advice. Consult your financial, tax or
legal advisor regarding your own unique situation and your company's benefits
representative for rules specific to your plan.
mPower is the
premier online community resource for 401(k) participants
Copyright ý 1996 - 2000 mPower. All Rights Reserved.
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