Investing in company's stock within your 401(k) is admirable, but it doesn't take much to get carried away.
Horror stories of Enron's collapse abound and anyone who's aware of the rapid drop in Enron stock prices is also aware of how quickly most employees lost their financial security.
All told, employees participating in Enron's 401(k) plan lost massive amounts of money, and in the case of WorldCom employees, they lost over1 billion dollars.1 One of the biggest reasons for such a collapse in 401(k) savings was due to the large amount of Enron and WorldCom stock employees held in their own plans.
While the outcome of the Enron collapse certainly wasn't pleasant, it at least allows us to step back and recall a few key reminders when it comes to 401(k)s. Being loyal to ones company is generally considered a very noble trait. You probably have a great deal of pride in your work and in the company you work for. But, loyalty aside, there is also something to be said about diversification.
Granted, you know your company better than most other companies you could invest in, but in the end, they're all corporations, and the Enron employees thought they knew better, too. The truth is, not all companies are doing as well as they claim. Even if they are, there's always risk in investing too heavily in your own employer.
While people have become more aware of the dangers of over-investing their 401(k) since the Enron and Tyco scandals, the problem still exists. According to a 2004 survey by the Employee Benefits Research Institute, 13% of those employees surveyed, had over 80% of their 401(k) allocated in their own company's stock!
Expert recommendations vary. Generally, it is said that you should have no more than 15% of your 401(k) invested in your own company. That's the maximum, but most experts believe you should invest even less than that. (Most say 5-10%, or below is a good number.) Most professionally managed, defined-benefit pension plans only contain 2% of the employers stock.
But there are exceptions to the rule. It's generally accepted that if your 401(k) plan is only one part of a much larger retirement saving strategy that includes IRAs and other investments. At that point, 15-20% of employees stock may be the right amount, as long as the overall amount in all combined retirement accounts is less than 10%.
Many people find it difficult not to invest in their own companies heavily, given many of the incentives that are available. Loyalty always plays a part in deciding whether or not to invest in your own company. Your employer may be another deciding factor. At Enron, they strongly encouraged employees to fill up their 401(k)'s with company stock. By the time the bottom fell out, Enron employees, on average, had 58% of their 401(k) invested in the company!
As with everything in life, sometimes you can have too much of a good thing. It's important to meet with a financial professional whenever you're deciding how to invest your 401(k). In general, when it comes to your own company, you want to stick with the 5-10% rule within the 401(k), or less than 10% invested overall. It's also extremely important to periodically step back and make sure you're keeping your investments balanced and diversified.
Lawrence D. Sprung, CFP of Mitlin Financial Inc., is a Registered Representative with Securities America, Inc., a Registered Broker/Dealer, member NASD/SIPC. Advisory services offered through Securities America Advisors, Inc., A SEC Registered Investment Advisory firm. Lawrence D. Sprung, Investment Advisor Representative. Mitlin Financial, Inc. and Securities America are unaffiliated. He can be reached at (631)465-2017 or by e-mail at email@example.com. Feel free to forward any questions or future topics you would like to see discussed to firstname.lastname@example.org and put longisland.com in the subject line.
1-Brown, J. Owning Company Stock in Your 401(k) Can Lead to Trouble. Knight Ridder Tribune News Service. 18 July 2005.