COMPANY STOCK: HOW MUCH IS TOO MUCH?

After Enron, WorldCom, and a host of other public companies that have either collapsed or taken nosedives in value in recent years, you would think workers would know better.

Common wisdom among financial advisors is that workers participating in company-sponsored 401(k)-type retirement plans generally should have no more than 10 percent of their account's assets invested in their employer's stock. Yet according to a recent study by the financial research company, Greenwich Associates, company stock accounted for 23 percent of account values.

To the workers' credit, that 23 percent is down from 33 percent in 2001, according to a Hewitt Associates study.[old FPP on overloading on company stock] But these were only averages. A 2003 study by the Employee Benefits Research Institute and the Investment Company Institute found that 13 percent of employees allocated over 80 percent of their 401(k) to company stock.

So what are the risks of having too much company stock in your 401(k) and how much should you hold?

One of the risks of overloading on company stock is the same risk smart investors try to avoid in any portfolio: Too much of any single stock magnifies a loss in that portfolio should that stock's fortunes sag. In fact, this applies to general asset classes. Too much of a single asset class (not just stocks, but bonds, real estate, and so on) makes the portfolio more vulnerable to a change in markets.

That's one reason that, according to Greenwich, the average defined-benefit pension plan, funded by the employer and professionally managed, maintains only 2 percent in its own company stock. (The law also limits pension plans to holding no more than 10 percent in their own firm's stock; there are no restrictions for 401(k) plans.)[NASD WARNING]

And there can be a second whammy to such declining stock values. Beyond putting at risk retirement portfolios laden with company stock, the same forces causing the stock to sag may simultaneously cause plan participants to lose their job and income.

Advisors further recommend the precaution of diversifying away from your employer's industry. If you work in a high-tech company, for example, you may want to minimize your holdings in other companies in the tech industry, which may be offered through mutual funds in your retirement plan. Otherwise, a downturn in the industry could hurt your company's stock, your job, as well as your industry holdings.

How much employer stock you should own is a more difficult answer. Generally, the advice is that it should never exceed 5 to 10 percent of your entire investment holdings.

Your retirement plan at work may constitute your entire portfolio. Or it might be only a portion of a larger portfolio that includes individual retirement accounts, taxable investments, and your spouse&'s retirement plan. Thus, your 401(k) account itself might hold more than 15 or 20 percent in company stock, or even more, as long as it doesn't constitute more than 10 percent of your overall portfolio.

Sometimes it's difficult to keep company stock down to 10 percent. First, employees typically know their company better than most investors and may feel loyalty toward its stock. Their employer may aggressively encourage them to buy and retain company stock (a reason why Enron employees averaged 58 percent of their 401(k) assets in company stock)

Some companies match employee plan contributions only with company stock instead of cash, though the percentage of companies with this requirement has declined to less than 20 percent.[Greenwich] Nonetheless, contribute enough to earn that match even if it's company stock' it's free money!

The company also may restrict your ability to sell its stock. You may not be able to sell within a certain number of years, during a certain time, or before a certain age, though companies are loosening restrictions.

Workers fail to periodically rebalance their retirement plan, which can allow a company stock that&'s doing well at a particular moment to become heavily overweighted.

There can be a tax advantage to owning company stock, called 'net unrealized appreciation.' This strategy allows the employee to withdraw company stock from the retirement plan at a more favorable tax rate than if the stock is left in the plan and later taken out as a standard withdrawal subject to ordinary income taxes.

Still, when all is said and done, say many advisors, workers generally should avoid overinvesting in their employer&'s stock.

This column is produced by the Minnesota Chapter of the Financial Planning Association; 612-789-4799; www.fpamn.org; email: office@fpamn.org. 

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