Will Company Stock Help — or Hinder — Your Retirement Dreams?
Most people watch the high-profile implosions of companies such as Lehman Brothers and Circuit City with a mixture of horror and fascination. Companies that big simply aren't supposed to crumble so quickly. But it happens. And many of the employees of such companies, in addition to losing their jobs, lose their retirement savings as a result of holding large amounts of company stock.
A recent survey found that 22% of employees at large companies hold half or more of their 401(k) balance in company stock. In other words, about one in five is so heavily invested in employer stock that the bulk of their retirement savings would be at risk if their employer were to fail.
Did you know that if a mutual fund wishes to meet the diversification standards of the Securities and Exchange Commission, it can invest no more than 5% of its holdings in the stock of any one company? The Department of Labor limits the amount of company stock a company can hold in a traditional pension plan to 10%.
Given that these regulatory bodies have established such strict limits, it's worth considering: What level of commitment to any one security is appropriate for an individual investor within his or her 401(k)?
The answer is a little less clear-cut than you might expect. It depends on how much of your total retirement holdings are contained in your retirement plan at work. The Sound Mind Investing philosophy is that all of your long-term investments go into the same "pot," and it is the portfolio mix of the entire pot that matters.
For example, assume that all of your retirement plan assets are worth $100,000, but only $25,000 of that is in your 401(k). If you invested 32% of that $25,000 in your company stock, your holdings would amount to $8,000. This is a reasonable amount in a $100,000 portfolio. On the other hand, if $80,000 of your $100,000 was in your 401(k), then a 32% allocation would mean that $25,600 was invested in your employer's stock. This is too high.
How is it that so many employees hold so much company stock in their 401(k)? The four most common ways this happens are:
- stock-purchase plans that let employees buy shares at a discount;
- stock-options being given to employees;
- company stock offered as an option in 401(k) retirement savings plans; and
- companies using their stock to match employee contributions into 401(k) plans.
The reasons many fail to prudently limit their investments in their company stock are both emotional and financial. They include the fear of being considered disloyal, fear of "missing out" if the company stock does well, peer pressure from co-workers, wanting to take full advantage of stock offered at low prices (or even free), and blind optimism concerning the company's future. From a strictly financial view, it's foolish to pass on free money given in the form of options and 401(k) matching. But where many workers fail is in diversifying out of their employer stock as they are given the opportunity.
So how much company stock is too much? There is no hard and fast rule concerning this because individual situations can vary widely. However, a general range that is useful is to limit your investing in any one stock (your company or otherwise) to 5%-15% of your total investable assets. Given that you already have so many of your financial eggs in your employer's basket, the lower end of that range is probably more appropriate. Also, the smaller the value of your total portfolio, the more you should gravitate to the lower end of the range.
Should you find yourself in a situation where you need to diversify (i.e. unload some of your company stock and buy something else), consider spreading out your selling over several tax years. This minimizes both the tax impact (for shares held outside your retirement plan) as well as the risk of selling too much during a period of market weakness. If your retirement plan allows you to switch between investments within your retirement plan, check out your other options. It may be easier to diversify than you think.
If you own company stock within your plan that has appreciated significantly in value, it's worth discussing with a tax professional the best way to liquidate it. Depending on your age and situation, there may be ways to take advantage of the lower tax rates for long-term capital-gains.
Published February 18, 2009
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Published since 1990, Sound Mind Investing is America's best-selling financial newsletter written from a biblical perspective.
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Originally published February 17, 2009.
