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Will Company Stock Help  or Hinder Your Retirement Dreams?

By Austin Pryor and Mark Biller
Sound Mind Investing

CBNMoney.comWhen a 1996 study revealed that a towering 42 percent of the money in large company retirement plans was being invested by employees in the stock of just one company  their employer  it rocked the retirement plan community. Several years later, despite watching the high-profile implosions of retirement plans at companies like Enron, Worldcom, and HealthSouth, the numbers weren't much better. Overall, the percentage of assets invested in company stock at large companies had declined to 32 percent. Unfortunately, nearly one in five employees still had plans with more than half the assets invested in company stock.

If a mutual fund wishes to meet the diversification standards of the Securities and Exchange Commission, it can invest no more than 5% of its holdings in the stock of any one company. The workers in these studies, therefore, are six times more concentrated than the government's standard of prudence would suggest. Is this higher level of commitment to one security appropriate?

The answer depends on another question: How much of your total retirement holdings are contained in your retirement plan at work? The Sound Mind Investing philosophy is that all of your long-term investments go into the same "pot," and it is the portfolio mix of the entire pot that matters. For example, assume that all of your retirement plan assets are worth $100,000, but only $25,000 of that is in your 401(k). If you invested 32 percent. of that $25,000 in your company stock, your holdings would amount to $8,000. This is a reasonable amount in a $100,000 portfolio. On the other hand, if $80,000 of your $100,000 was in your 401(k), then a 32 percent. allocation would mean that $25,600 was invested in your employer's stock. This is, in our opinion, too high.

How is it that so many employees are building such a significant stake in their company's future? The four most common ways this happens are: stock-purchase plans that let employees buy shares at a discount, stock-options being given to employees, company stock offered as an option in 401(k) retirement savings plans, and companies using their stock to match employee contributions into 401(k) plans. All of these avenues have one thing in common  the employee gets a  "good deal" on the company stock, either receiving a discount from current market value or, in the case of 401(k) matching programs, getting shares "for free."

Obviously, there are pitfalls that arise from being dependent on a single company for one's income, health and life insurance, and retirement investments. Consider the risk of those in troubled companies during the current recession  not only did many lose their jobs and health benefits, but they also watched the value of their retirement assets plummet as the price of their company’s stock fell.

Even blue-chip members of the Dow Industrials aren't exempt. Look at the plight of Boeing employees, for example: starting in mid-2001, not only were over 36,000 employees laid off, but the stock value dropped as much as 60 percent.

The reasons that many fail to prudently limit their investments in their company stock are both emotional and financial. They include the fear of being considered disloyal, fear of "missing out" if the company stock does well, peer pressure from co-workers, wanting to take full advantage of stock offered at low prices (or even free), and blind optimism concerning the company's future. From a strictly financial view, it's foolish to pass on free money given in the form of options and 401(k) matching. But where many workers fail is in diversifying out of their employer stock as they are given the opportunity.

Don't underestimate the powerful appeal of loading up on company stock, especially for those working for the dynamic companies of recent years. For much of the 90's it was hard to pick up a business magazine without reading about a company secretary at some hot company who was retiring early as a millionaire due to parking their 401(k) money in company stock. Even with some stock prices down tremendously since then, there is still a belief among some employees that those type of outsized returns can and will occur again.

So how much company stock is too much? There is no hard and fast rule concerning this because individual situations can vary widely. However, a general range that is useful is to limit your investing in any one stock (your company or otherwise) to 5 --15 percent. of your total investable assets. The smaller the value of your total portfolio, the more you should gravitate to the lower end of the range.

If you find yourself in a situation where you need to diversify, you might consider spreading your selling out over several tax years. This minimizes both the tax impact (for shares held outside your retirement plan) as well as the risk of selling too much during a period of market weakness. And if your retirement plan allows you to switch between investments within your retirement plan, check out your other options. It may be easier to diversify than you think.

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