This article was written by Simon Moore, CFA, MBA, of FutureAdvisor for Manilla.com
The investment choices for 401(k) retirement plans are menus with some great options, like low-cost diversified index funds, some mediocre ones, like most mutual funds, and one choice that makes little sense at all. That's buying stock in your employer.
It's like a vegetarian restaurant decided that right under its soups and salads, it would offer health-conscious clientele a solid slab of butter at a cut-rate price. Too much butter will give you heart disease, and too much employer stock will give you a bad retirement.
People hold too much employer stock in their 401(k)s
In plans that allow it, almost one in five of all of 401(k) dollars is invested in employer stock, according to 2013 data from the Investment Company Institute (ICI) and the Employee Benefits Research Institute (EBRI). Seasoned financial advisers would caution against large exposure to any single stock, let alone one's employer. After all, your entire salary is already a bet on that one company -- there's no need to increase your exposure.
Even worse, some people hold lots of employer stock. The same EBRI report found that 7 percent of retirement savers held more than 80 percent of their 401(k) in employer stock. Now that's loyalty. But it's doing savers little good.
For these people, betting most of their retirement investments on a single company is extremely risky.
Even though the S&P 500 gained more than 20 percent over the past 12 months, about 70 stocks on the NYSE and NASDAQ have fallen by more than half in that period, according to Financial Exchange Protocol data.
This is sort of stock decline is a terrible outcome for employees who were backing these companies with their 401(k)s. They just downsized their golden years. These companies show how engaging in stock picking with your 401(k) can be extremely risky.
A few examples of employer-stock risks
According to Google Finance, Journalists at the New York Times, many of whom were heavily invested in the premier American newspaper, saw its stock dive from more than $51 in 2002 to less than $5 in 2009. An order of magnitude decline that ruined many plans made for retirement.
The poster child for this type of mistake is Enron, an energy trader once based in Houston, which declared bankruptcy in 2001. Some married couples who worked together at the company lost nearly a million dollars from their retirement savings. Diversification would have saved them a lot of grief.
Enron is not an isolated example. Lehman Brothers, WorldCom, Chrysler, Washington Mutual and General Motors all show that large bankruptcies, often of companies that are household names, happen frequently. The nature of the free market means your employer is also free to fail. Make sure you don't go down with them, no matter how promising they seem now.
It's tempting, but risky
Some argue that if their employer does well, the stock will rise in value. That's true, but if your employer does well, you will benefit in many other ways. You career prospects may improve and your pay is more likely to increase.
You are already invested in your employer more than you think. It's also tempting to think that you should invest in what you know, and so hold your employer's stock. In fact, a low-cost stock fund offers a much less risky way to track the growth of America's best companies without being over exposed to any single one.
What to pick instead
Look for a low-cost broad stock fund for most of your retirement savings. Balance out the risks of holding stocks, which do well in the long term but can fall sharply and unexpectedly in the short. Expose your savings to bonds, real estate assets and inflation-protected securities.
So as you approach retirement, gradually reduce your stock exposure in favor of bonds and inflation protected securities. Just because there's junk food for sale at the supermarket doesn't mean you should buy it. And just because employer stock is a 401(k) option doesn't mean you should choose it.
You probably have more financial exposure to your employer than you realize, and investing more in that one stock could put your retirement at risk.
Simon Moore CFA, MBA, is a regular contributor to The Manilla Folder at Manilla.com, the leading, free and secure service that lets you manage and share your bills and accounts in one place online and via mobile apps. He is Chief Investment Officer at the award-winning *investment manager* FutureAdvisor. FutureAdvisor provides an online service to analyse and improve upon your retirement savings choices. It takes only a few minutes. See your free analysis at www.futureadvisor.com.More from Manilla.com:
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