Don’t Overload Your 401(k) with Company Stock

Your 401(k) may be a great retirement-savings vehicle. Your earnings grow on a tax-deferred basis, and you typically fund your plan with pretax dollars, so your contributions can lower your annual taxable income. Plus, you may even get an employer match. But if you’re really going to get the most out of your 401(k), you will need to pay close attention to your investment mix and change it at the right times.

And now may be a particularly good time to review your 401(k) for possible moves in one key area: the percentage of employer stock in your plan.

Company stock can be risky business
One of the biggest mistakes many people make is to put too much company stock in their 401(k) plans. This can expose you to significant investment risk as recent history shows.

According to a 2003 study by the Profit Sharing/401(k) Council, about 58 percent of employees & 401(k) assets were invested in Enron stock when it lost almost all of its value during 2001. Yet, since then, many workers have continued to invest heavily in company stock in their 401(k) plans. In fact, according to the Profit Sharing/401(k) Council, some 17 percent of all 401(k) participants have 50 percent or more of their account in company stock much the same figure as the pre-Enron days. In the December 2004 CFO Magazine (CFO.com), the magazine wrote that other big employers in a range of industries, including Marsh & McLennan (insurance services), Merck (pharmaceuticals) and Delta Air Lines, have seen their stock prices fall sharply, causing such harm to their 401(k) plans that employees filed class-action lawsuits against the companies.

Do these episodes of 401(k) meltdowns mean that you should never invest in your company? Not necessarily, but most financial experts caution against putting more than 10 percent of your 401(k) plan assets into company stock.

Of course, everyone’s situation is different. If you are employed by a large, stable blue-chip firm, one with a long history of earnings through all types of economic environments, then you may feel justified in devoting a relatively higher percentage of your 401(k) dollars to your company stock. That’s not to say the stock price couldn’t go down. It will, at some point, but you will at least know your firm has acquired some important ‘survival skills’ over the years. Conversely, if you work for a young start-up firm, you might be less inclined to commit a large portion of your 401(k) to company stock. While its prospects may look good now, there’s no way of telling what the future holds.

Furthermore, the amount of company stock you hold in your 401(k) also should depend, in part, on where you are at in your career. The closer you are to retirement, the less dependent you will want to be on just one company, particularly if you plan on tapping into your 401(k) soon after you retire.

Take the match, but diversify
As you know, many employers offer company stock as matching contributions. Since this is essentially ‘free money,’ you may want to contribute as much as you can to your 401(k) to earn the full match. Fortunately, a growing number of businesses that award company stock in the form of matching contributions are now allowing employees to exchange those stock shares for other investment options within their 401(k) plans.

So strive to diversify your 401(k) holdings among the investment choices available to you. Many plans now offer a dozen or more options, so you should have no trouble spreading your dollars among stock funds, bond funds, government securities and other vehicles. Your asset allocation should be based on your risk tolerance, long-term goals and time horizon. To properly diversify your 401(k), you may want to consult with a financial professional.

Don’t limit your prospects
Do the best job you can for your employer, but don’t tie all of your 401(k) prospects to your company stock. Loyalty is fine but in the investment world, balance and good judgment are better.