Millions of Americans have a big chunk of their retirement assets directly or indirectly invested in their employers’ stocks—directly where employees have stock options or ESOP plans that give them company shares at discounted prices and indirectly where corporate retirement funds hold a big chunk of company stock. I want to show you why over-concentrating your investments in company stock is not such a good idea.
I’m going to start with a true story set in 2006, not too far from the nasty downturn in ‘08. That’s when a client of mine declared to me that he was getting ready to retire the next year. He had accumulated enough for retirement but much of his net worth consisted of his company’s stock—actually, about 2/3rds or so.
The shares he held had been pretty volatile over the years, ranging from a low of $20 to its current price of $65 which was a high point of its range. When asked at what price he would eventually sell, he said he’d sell half at $75 and the other half at $82 per share. With shares at $65, it didn’t appear unreasonable to expect they could rise to $75 and then $82, over a reasonable period of time.
Everything looked great under a rising stock scenario. Moreover, at $65, there was a high probability that the amount of money he had accumulated up to that point would last throughout his lifetime. So there was no problem with retiring next year. As a matter of fact, he could retire now according to the numbers. Just a note: This analysis also assumed a specific amount of future savings, an estimated future rate of return, a monthly retirement budget, and numerous other variables.
But what if the stock fell back to $20, which it had hit in the past? Well, then he’d see 2/3rds of his assets dramatically reduced; and the numbers showed that at $20 per share, he wouldn’t be able to retire now or next year, and in fact, it looked like he’d have to work another 10 years. So, with this deeper dive into his plans to retire, the original idea to squeeze some extra bucks out of the stock didn’t look so good. Do you think his company stock would be worth holding on to given the risk to his retirement plans? Or would it make more sense to sell the stock now and reinvest the proceeds into a diversified portfolio, perhaps with no more than 5%-10% allocated to his company stock as part of a prudent, well-diversified investment strategy?
The lesson here is that a company doesn’t have to go out of business like an Enron or Lehman Brothers to ruin your future plans. Diversifying out of a heavy position of company stock, especially when nearing retirement, is almost always a sound decision, irrespective of the potential upside of the stock.
Why Employees Like To Invest In Company Stock
First, let me point out that employees like buying company stock because they are under what psychologists call an illusion of control, where employees feel they know more about what’s happening inside their company and feel they have an insider’s investing edge that outsiders lack.
Companies also incentivize employees to buy shares for less-than-market prices through stock options and Employee Stock Ownership Plans, or ESOPS, as they’re known. Purchasing company stock at a discount makes a lot of sense, especially if you can buy shares for 15% less than market value, and for such plans, I understand if you want to go all in and buy as much as you can.
There’s also a sense of loyalty in buying company stock. Additionally, we’ve all heard real-life stories of thousands of employee-millionaires at companies such as Amazon, Berkshire Hathaway, Facebook, Google, and Microsoft, where even lower-level employees with a few hundred shares make significant amounts of money over a few short years.
But sometimes, employees may simply not be aware that they can diversify by changing their asset allocation to a smaller percentage of company stock. In other instances, inexperience with investing or the fear of market volatility pushes people towards the comfort and familiarity of their own company and its stock.
So there are multiple reasons why employees like buying company stock.
But there is such a thing as having too many eggs in one basket—especially with one’s investments and retirement savings—because if your company, heaven forbid, gets into trouble, you could be hit by the double-whammy of losing a job and watching your investments drop in value. Think Enron and Lehman Brothers where retirement plans were wiped out and employees found themselves without jobs,a fate that you can avoid if you diversify your investments beyond company stock.
Too Close To Be Rational
Unless you’re the CEO, CFO, or someone privy to a company’s detailed financial data, you really may not know too deeply into how your company’s actually performing. Furthermore, an analysis of real insider buying and selling data shows that even C-Level Executives are bad predictors of their own stock’s future arc.
Here’s another reason to not drink too much of your own company’s Kool-Aid: more than half of all publicly traded companies have not outperformed a cash equivalent investment in their lifetimes as publicly traded companies. So even if you love your company, there’s less than a 50-50 chance that it will outperform cash and much less that it will beat the market. Just as a doctor wouldn’t operate on her own child, so it is with your company. When you’re too close to it, you may lose the ability to think rationally and may not be able to spot its flaws, especially if you’re not in a customer and competitor facing role.
There’s also a “groupthink” issue where you conform to what your co-workers are doing and vice-versa, and all of you end up holding more of your company stock than you should. Add in confirmation bias—which I have discussed several times on this show—where you believe in a position and do not let outside data change those beliefs. So if you strongly believe your company is strong and competitive, confirmation bias may cause you to dismiss competing views or early alarm bells, and you’ll end up holding your company’s stock, perhaps even buying more when it’s down, only to realize your mistake when it’s too late.
Now’s The Time To Diversify
With the market having done so well over the past eight years, those of you who have a big chunk of your portfolio tied up in company stock should seriously consider diversifying because most company shares have performed really well over the past year and may drop 10% to 15% in a routine market correction, or even more if things somehow take an ugly turn. So I’d urge you to speak with your financial advisor, weigh your risks, and be open to diversifying beyond your company stock.
Some of you may point to Google and Amazon and say that if their employees sold too early, they wouldn’t have been millionaires, and I see that, so let me caveat this: If you’re relatively young, have few responsibilities, and work for a promising company that’s got a distinct advantage, it may make sense to hold a large percentage of your portfolio in company shares. But as you age, raise a family, have to pay for a house, save for college, and your own retirement, consider paring back on your allocations so you spread your risk.
It may be emotionally difficult to sell most of your company stock, so it’s okay to maintain a reasonable position of no more than 5%-10% of your total portfolio in company shares, provided your company is a leader in its field. But if your company is a laggard, then even 10% may be too much and could border on being reckless.
There are lots of ways to stay true to your company, but putting your family’s finances at risk isn’t one of them. You may be better off biting the bullet, selling most of your company stock, and diversifying your portfolio.
Investing involves risk and investors should carefully consider their own investment objectives and never rely on any single chart, graph, or marketing piece to make decisions. The information contained herein is intended for information purposes only, is not a recommendation to buy or sell any securities, and should not be considered investment advice. Please contact your financial advisor with questions about your specific needs and circumstances. There are no investment strategies, including diversification, that guarantee a profit or protect against loss. Past performance doesn’t guarantee future results. Equity investing involves market risk, including possible loss of principal. All data quoted in this piece is for informational purposes only, and author does not warrant the accuracy, completeness, timeliness, or any other characteristic of the data. All data are driven from publicly available information and has not been independently verified by the author.