Diversification

Too Much of a Good Thing?
Investing in company’s stock within your 401(k) is admirable,
but it doesn’t take much to get carried away.

Corporate scandals like those of Enron, Tyco and WorldCom will eventually become a note in business
history texts, but for many who lost considerable retirement funds, the results affected their lifestyle in
retirement years and their ability to build an estate for future generations.

Employees participating in Enron’s 401(k) plan lost massive amounts of money, and in the case of
WorldCom employees, they lost over $1 billion. One of the biggest reasons for such a collapse in 401(k)
savings was due to the large amount of Enron and WorldCom stock employees held in their own plans.

While the outcome of the Enron collapse certainly wasn’t pleasant, it at least
allows us to step back and recall a few key reminders when it comes to 401(k)s.
Being loyal to one’s company is generally considered a very noble trait. You
probably have a great deal of pride in your work and in the company you work for.
But, loyalty aside, there is also something to be said about diversification.

Granted, you know your company better than most other companies you could
invest in, but in the end, they’re all corporations, and the Enron employees
thought they knew better, too. The truth is, not all companies are doing as well as
they claim. Even if they are, there’s always risk in investing too heavily in your
own employer.

While people have become more aware of the dangers of over-investing their
401(k) since the Enron and Tyco scandals, the problem still exists. According to
a 2004 survey by the Employee Benefits Research Institute, 11% of those
employees surveyed had over 80% of their 401(k) allocated in their own
company’s stock.

Expert recommendations vary.  Generally, it is said that you should have no
more than 15% of your
401k invested in your own company. That’s the maximum,
but most experts believe you should invest even less than that. (Most say 5-10%,
or below is a good number.) Most professionally managed, defined-benefit
pension plans only contain 2% of the employers stock.

But there are exceptions to the rule. It’s generally accepted that if your 401(k)
plan is only one part of a much larger retirement saving strategy that includes
IRAs and other investments. At that point, 15-20% of employees stock may be
the right amount, as long as the overall amount in all combined retirement
accounts is less than 10%.

Many people find it difficult not to invest in their own companies heavily, given
many of the incentives that are available. Loyalty always plays a part in deciding whether or not to invest
in your own company. Your employer may be another deciding factor. At Enron, they strongly encouraged
employees to fill up their 401(k)s with company stock. By the time the bottom fell out, Enron employees,
on average, had 58% of their 401(k) invested in the company.

As with everything in life, sometimes you can have too much of a good thing. It’s important to meet with a
financial professional whenever you’re deciding how to invest your 401(k). In general, when it comes to
your own company, you want to stick with the 5-10% rule within the 401(k), or less than 10% invested
overall. It’s also extremely important to periodically step back and make sure you’re keeping your
investments balanced and diversified.

1-Brown, J. Owning Company Stock in Your 401(k) Can Lead to Trouble. Knight Ridder Tribune News
Service. 18 July 2005.
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