Finally – July 2012 has arrived! Employees all over America will get the sobering news that there really are fees being siphoned out of their 401(k) accounts and the amounts, will hopefully generate “shock and awe.” Fees will now begin to compress and over time, employers will begin offering low cost index funds to employees, and there will be a mass migration out of expensive actively managed funds and into lower cost funds or target date funds. Hopefully, this higher level of disclosure and transparency will save American workers literally billions in future fees.
Another equally important 401(k) topic is whether you should own company stock in your 401(k). Today, nearly 50% of all 401(k) plans offer participants company stock and of those participants, 28% held more than 20% and 5% held more than 80% of their 401(k) money in company stock. Nearly 66% of large companies offer company stock to employees.
If you own company stock in your 401(k), take some sage advice – sell it. Not some of it but sell every single share.
Look no further than Enron’s bankruptcy in December 2001. At the end of 2000, 62% of Enron employees’ 401(k) assets were invested in Enron at nearly $80 per share. In the next year, these employees who felt they knew their company, watched their holdings drop to less than $.070 per share – and then you lost your job. If you were a Lehman employee, you probably owned a fund called the Lehman Brothers Stock Fund which had over 10% of it’s assets in what became worthless Lehman stock.
In 2009, International Paper had cash problems because of the recession and began matching employee 401(k) contributions with company stock instead of cash. In the last 12 months hundreds of the world’s largest companies are down large amounts, like Alcoa down -48%, Citigroup down -36%, Caterpillar down -27%, Ford down -31%.
Your retirement fund is the nest egg that you will rely upon one day to pay your bills when you are too old to work. When you own funds that are properly diversified, no one company can have a marked impact upon your portfolio. That’s why owning literally thousands of stocks and bonds is critical. The closer you get to retirement, and the larger your 401(k) becomes, the risks of not being adequately diversified are great.
Those who argue with this position say: “But I have insights into my company and I have an edge. I know what is going on.” Many enjoy feeling “part of things” at work. Many feel “safer” owning company stock because they believe they understand the company and have insights. Owning company stock may be a quiet demonstration of loyalty – as if bosses are calculating how much of one’s 401(k) is invested in company stock.
These are interesting arguments, but they are simply irrational from an investment standpoint. Your 401(k) is for only one purpose: to fund retirement. And therefore, risk management is a critical issue. Having any individual stocks instead of owning thousands is just not prudent. And if you believe that just because you work at a company that you have some kind of an edge, don’t kid yourself. Even management is often unaware of important issues driving their own companies – ala JP Morgan and the London Whale.
Lisa Meulbroek who chairs Financial Economics at Claremont-McKenna College wrote in a study on this topic: “Because employee investors earn exactly the same returns as fully diversified investors, but are exposed to greater risk, holding company stock is inefficient for all employees, irrespective of their risk tolerance.” When you own your company’s stock, you aren’t getting compensated for the increased risk you assume.