Strategies for Company Stock in Your Portfolio

By Clifton Linton
Senior Writer, mPower

If you had a $4 million nest egg, you'd think you wouldn't have any worries about retirement.

But what if all that money were tied up in a single tech stock?

That's the situation Certified Financial Planner Kim Dignum confronted in 2000 with one of her clients. He had built a $4 million retirement account consisting entirely of stock in Intel Corp.

Last year, before the market dropped, the client decided to retire. Dignum recommended he diversify his portfolio. He balked, but finally agreed to move $1 million into bonds.

Then the market fell, taking technology stocks with it. From the July 31, 2000 high of $75, Intel Corp. shares lost 60 percent to current levels near $30. His reaction: "Why didn't you ask me to do $2 million?" Dignum said.

Dignum said she had another client in a similar situation who didn't listen to her advice. He bought company stock during his career with a phone company, and he didn't diversify. When he retired, telecom stocks tanked and now he's back at work. "This guy doesn't have money to retire," she said.

Sharing in your employer's profits can make work more fun and can help you build up your portfolio significantly if your company does well. But owning too much company stock, both inside and outside your retirement portfolio, is like putting too many eggs in the proverbial basket. If your employer experiences a downturn, not only could you be out of a job, but your portfolio could also take a major hit.

How Much Is Too Much?
In January 2001, Gary Learned quit his job at General Electric Co. and began life as a retiree. In his 17 years at GE he built up a nice 401k balance — all in GE stock. Today, that represents 50 percent of his assets.

Learned, 57, agrees that's a large position, but says he's comfortable with it. "I'm okay with a certain amount of risk-taking," he said. He views the stock as a long-term investment that he doesn't plan to tap until 2006.

The stock has held up in the midst of recent market declines. But, what if it falls? "If I need the stock to be (at a certain price) and it isn't, I'll have to face that" at the time, he said. "Will I diversify over the coming years? Probably."

Today, he's living off the cash value of his whole-life insurance policies. He expects to receive a pension in 2004.

Even though Learned has a plan and his company stock is in a stable and profitable company, his large position is a red flag, according to financial planners interviewed for this article.

CFP Timothy Schannep encourages clients in similar positions to diversify their holdings. Spreading investments among several asset classes reduces a portfolio's volatility while helping to keep returns fairly constant. A big position in a single stock can upset that balance.

"In investing, it is possible to have too much of a good thing," said Schannep, of U.S. Bancorp Piper Jaffray, in Tucson, Ariz.

For many workers, there's no shortage of ways to acquire company stock. It is often available through Employee Stock Ownership Plans (ESOP), profit-sharing plans, as a bonus, as a 401k-plan matching contribution, and as a 401k investment option. Many workers also buy company stock in their personal brokerage accounts.

Schannep suggests clients keep company stock holdings at a maximum of 20 percent of their overall portfolio (retirement savings plus other investments), but "I would like to see closer to 10 percent." Other planners agree on 10 percent.

Yet, according to a 1999 study by the Employee Benefit Research Institute, in plans where employer-matching contributions were made with company stock, on average 29 percent of the account balances directed by the participant (separate from the employer match) were also invested in company stock.

Statistics back up planners' caution. In 1999, the Schwab Center for Investment Research looked at the impact that holding a single stock can have on a portfolio. The larger the holding, the higher a portfolio's volatility, Schwab found. While the study didn't reveal an optimum level of company stock, it did highlight a key cut-off — 30 percent.

If the percentage of company stock is larger than that, "the risk of that holding takes on such a large weight, it skews the risk of your portfolio," said Bryan Olson, director and principal researcher at Schwab. "You have greater volatility." That could reduce the likelihood of reaching your savings goals.

But company stock isn't necessarily a bad investment. On the contrary, there are some definite advantages to owning a reasonable amount of stock in a solid employer.

Pride in Ownership
One of the biggest pluses of owning company stock is that it can make you feel good about coming to work. Many people like jobs where they have the chance to participate in the profits they create, points out Scott Lummer, chief investment officer for mPower Advisors, L.L.C. mPower provides investment advice to retirement plan participants and publishes this Web site.

Lummer's own investment in mPower represents 15 percent of his total portfolio, which he admits comes close to the worrisome thresholds planners use. He fully understands the risks connected with his investment. But his reason for owning company stock is not entirely dollars and cents. "I like owning company stock," he said. "The pride in ownership motivates me. ... And, I like working for a company that encourages employee ownership."

This workplace pride is also why Learned still believes in his GE stock. "I'm not sure I would be doing that with another employer's stock," he said.

Tax Advantages
If you own company stock in your retirement plan and handle it correctly, you may get some tax breaks. The first comes when stock is distributed from the plan. If you take the distribution in certificates, rather than cash, you only pay taxes on the original purchase price instead of the current value.

You will have to pay taxes on the appreciation when you sell the shares. But, if you have held the stock for more than a year, you will be taxed at the long-term capital-gains rate, which might be less than your income tax rate. (It's generally not a good idea to roll company stock into an IRA because IRA distributions are taxed as ordinary income.)

A big advantage comes if you pass the stock to your heirs. Current inheritance laws let heirs take a stepped-up basis when selling the stock. If you bought stock for $10,000 and it was worth $50,000 when you died, the IRS would consider that your heirs acquired the stock at $50,000, rather than $10,000 (your original purchase price).

Of course, if you need the money in the stock right away, don't let the tax situation rule your decision to sell, said Ted Benna, who designed the first 401k plan.

Company Stock Strategies
Here are a few things to keep in mind about company stock:

• Don't ignore this perk. If your company is giving you stock through a profit-sharing plan or as a 401k match, or even to purchase at a discount through an ESOP, take it. "My feeling is ... take all the stock you can get that the company gives you," Benna said. But, be wary if your employer also actively promotes company stock as a 401k investment option, Benna said. This is where you have the opportunity to diversify your retirement portfolio with other investment options. Benna said he considers it a disservice to employees when employers push company stock as a 401k investment option, because it could leave employees without proper diversification.
• Be sure to include your company stock holdings in your allocation decisions for your entire portfolio. You can offset a big company-stock position by investing other money in mutual funds that don't invest in your employer or any other companies in the same industry, Schannep said.
• Keep company stock in check, at the level you determine is right for your portfolio. You may not be able to sell stock received as company contributions to a retirement plan or a profit-sharing plan. However, you can reduce your investments in company stock in the 401k plan, and you can methodically sell stock purchased through an ESOP.
• If you want to reduce a large position in company stock, don't sell the stock all at once, Dignum advises. She recommends using reverse dollar-cost averaging. By selling a fixed amount at regular intervals, you should get a higher price on average for your stock than you would with a one-time sale.

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.