Avoid a Company Stock Meltdown in Your 401k

By Clifton Linton

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 401k 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 401k 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 401k plan rules, in favor of more diversified investments.

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 401ks, 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.

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 401k, 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 401k 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 401k reform proposals. It's possible that some legislation may eventually pass placing limits or restrictions on company stock held in 401k plans.

But this could take time, and investors shouldn't wait. If you're concerned about company stock in your 401k plan, use our guidelines to assess and act on your own situation.

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.