 Three's Company Stock
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By Scott
Lummer
Chief Investment Officer, mPower
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Sorry about the title, but I've always been a fan of
Suzanne Somers.
This week's question is ...
It has been advised that no more than 15 percent should
be invested in company stock. Does this include employees of Fortune 500 companies? I am
in my early 30s and happen to be employed by a Fortune 10 company. Do these circumstances
up the ante to where I can allocate 30 or 40 percent to company stock?
This is a tough question. In fact, it's so tough that the
investment advice company I work for, mPower, does not give specific advice to clients on
how much company stock a person should own. The reason is that there are many conflicting
factors in making this decision, and most of those factors are very personal. So what we
do for our clients, and what I will do for you, is list the pros and cons of owning a lot
of employer stock. The more pros apply to you, and the fewer cons, the more you may invest
in company stock.
The reason I'm a bit more philosophical about this issue
than many financial advisors is that I have a great deal of my portfolio tied up in mPower
stock (although not in my 401(k) plan). Since mPower isn't yet publicly traded, this stock
is much riskier than average. Yet, I am very comfortable with my investment, and would
invest even more if I could. I also had a large proportion of wealth invested in my
previous employers' stock, and that worked out well. So in light of this, it would be
hypocritical for me to say "it's all right for me to have so much invested in company
stock, but you can only invest a maximum of 15 percent."
Now on to the pros and cons, or, I should say the cons and
pros, because I'm going to begin with the reasons against owning a lot of company stock.
Keep in mind that these guidelines apply to your overall portfolio. You might want to be a
bit more conservative with your 401(k) plan because, if your company takes a turn for the
worse, you can't sell the stock as easily as you can in investments outside the plan.
Dangers of Owning Company Stock
Inadequate diversification
There are many events, including product difficulties,
labor problems, competitive difficulties, or industry pressures, that can cause a share of
stock in an individual company to lose value. The benefit of owning a fund or a portfolio
of stocks is that you are insulated against the risk of one stock's price falling too far.
The average share of stock has about three times more volatility than the average mutual
fund. If stock in one company, including your employer, makes up more than 10 percent of
your overall stock portfolio, you are taking on a lot of company-specific risk.
Drinking from the same well
The company risk is magnified when you consider that the
additional portfolio risk you are taking comes from the same source as your paycheck.
Suppose your employer's sales decline, and your management is forced to lay off workers.
The stock price will likely decline, and your job may be at risk, or at least you may not
get the raises and bonuses you were hoping for.
Company risks are not created equal
Some companies are riskier than others (those of you who
have invested individually in dot-coms can attest to this). Many of the companies that
offer company stock as an investment option in their 401(k) plan have more risk than the
typical company. Obviously, the greater the stock's risk, the greater the impact on your
overall portfolio.
Other shares
It is possible that in addition to the stock in your 401(k)
plan, you may own stock through other sources, such as stock options, employee stock
ownership plans, and employee purchase plans. When evaluating your exposure to company
stock, you should consider your overall employer stock position — not solely the
stock in your 401(k) plan.
Benefits of Owning Company Stock
Invest in what you know
One reason why investing in individual stocks is not
advisable for most investors is that they usually know less about the company than do the
professionals with whom they are trading. However, in the case of employer stock, you may
have the advantage. If you feel that the security analysts who follow your company are
undervaluing the stock, you may benefit by purchasing it. On a related note, you probably
did some research before joining the company. Some of the same reasons that led to take
your job may justify investing in the stock (unless those reasons were the cool office
furniture and the good-looking human resources officer who interviewed you).
Pride of ownership
This may sound corny, but owning stock in my company simply
makes me feel better. I have more enjoyment from my work, and I like the fact that my
colleagues also own stock in the company. I think it motivates all of us to put forth a
stronger effort and it helps forge a stronger bond. Hey, I know all about lack of
motivation — I used to work for a university.
Company benefits
The common motivation doesn't only help the employees; it
also helps the company to be more efficient and productive. That, in turn, may make the
stock even more valuable.
Place for "extra" money
Most people are dependent on every penny of their 401(k)
plan to meet their retirement goals. But that is not the case for everyone (particularly
those who started investing at an early age and invested in addition to the 401(k) plan).
If you are not dependent on the proceeds from your investment in employer stock, you are
freer to take risks.
* * *
So there are the cons and pros. If you found this valuable,
please tell a friend about this site. You will be helping out my retirement plan.
 Lummer's Logic Archives
The information provided here is intended to help you understand the general issue and
does not constitute any tax, investment or legal advice. Consult your financial, tax or
legal advisor regarding your own unique situation and your company's benefits
representative for rules specific to your plan.
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