Are you holding your employer's stock in your 401k retirement plan? If your retirement account contains your company stock, you're not alone: about 46 percent of eligible employees hold their employers' stock, and one in five large companies invests employees' retirement money in its own stock, says Bloomberg.
Including your employer's stock in your 401k plan might not seem like such a big deal — especially if almost half of eligible employees are doing it — but the potential inherent risks have lead some wealth advisors to call out the practice, with descriptions ranging from "the most hazardous holding" to "potentially devastating" to "a scary movie."
What's causing so many 401k advisors to warn against this admittedly common practice? To find out, you can ask former Enron or WorldCom employees... or simply read on to learn what you need to know about the potential risks of holding company stock in your 401k account.
401k Advisors Reveal the Risks of Holding Company Stock
Though saving for retirement and investing may seem like two different activities, they do share some underlying guidelines, namely risk and diversification. To understand why holding too much company stock in your 401k isn't always a great idea, let's expand on these two basic concepts:
- Avoiding unnecessary risk
- Maintaining a diversified portfolio
The increased risk associated with holding too much company stock is easy to understand. When you depend on your employer for your income and hold a large amount of stock in your 401(k) account, you're exposing yourself to risk. If your company goes out of business, not only will you be deprived of a paycheck, but your nest egg will shrink, as well — in other words, a double financial whammy.
Holding too much employer stock also means that your portfolio isn't diversified. At Premier, we emphasize the need for true diversification, not simply across a range of equity securities, but across a range of asset classes, as well. If you're sinking a significant chunk of your retirement savings into one company's stocks, you're not diversified. The old saying "don't put all your eggs in one basket" certainly holds true in this case.
How Much is Too Much? 401k Advisors Weigh In
So is holding your employer's stocks always a bad idea? After all, many companies encourage — or even require — eligible employees to accept company stock as part of a 401k match plan. According to FINRA, while existing regulations prevent companies from investing more than 10 percent of their own stock into employees' traditional pension plans, no such restrictions are in place for 401k plans. In addition, employer stock often comes with strings attached, potentially limiting liquidity.
However, in some cases, holding employer stock offer certain benefits, such as the opportunity to purchase the stock at a discounted price. As such, this issue lacks a one-size-fits-all answer. While some investment professionals advise holding up to 20 percent of your account in employer stock, many wealth advisors generally suggest keeping your holdings from five to 10 percent, at most.
Take control of your retirement by setting maximum allocations of employer stock, both in your 401k plan and in your total portfolio. If the stock price increases, consider selling and taking the opportunity to diversify. If you leave your company, consider using net unrealized appreciation rules; these may allow you to distribute the company stock to a taxable account, while doing a 401k rollover to a new retirement account with the remaining funds. Speak with your trusted wealth advisor to determine the right solution for your needs.