401ks and other retirement plans make it very easy to own company stock. For some investors, owning stock in their employer might be the only individual stock holding they own. Most 401K plans are comprised of index funds and/or target date funds, making the company stock the only single stock holding in the plan. Owning stock in our employer makes us feel like we are a part of something bigger than ourselves and that our daily contributions at work pay off when the stock does well.
However, as with all investments, the long-term goal is to make money. If the company does well, then the value of your stock will grow, and you will benefit from that growth.
While owning company stock can be a good thing with plenty of upside, it’s my job to discuss the potential downsides – owning too much company stock. Owning too much company stock could create a lack of diversification and expose you to more risk than you need or even intended to own.
So, how much company stock is the right amount? Well, that depends on whom you ask.
Many retirement strategists suggest that a diversified portfolio should have no more than a 5%-15% position in any one company’s stock. The exact percentage each person should is based on their individual financial goals, risk tolerance and time horizon. No matter what, too much stock in a single company may lead to anti-diversification.
Personally, I believe it is important to run through a detailed financial analysis and stress test to determine if any concentration above 5-10% is appropriate. Analyzing the potential upsides and downsides of any concentration and the impact on an individual’s financial goals (i.e. retirement) will help ensure that no matter the outcome of a single holding, the long-term financial goals are intact.
That’s simple… No.
Having a large position in any single stock may immediately increase your risk level more than expected.
As Bob Farrell’s Rule #10 says, “Bull markets are more fun than bear markets”. This is especially true when having a large position in one company stock and that stock does well. However, I have never seen a stock go straight up for a long period of time. Stocks experience periods of fluctuation and during these times of fluctuation, a person with a highly concentrated stock position may see their account balance go up or down more than expected. This could cause emotional reactions, such as panic selling, that could create long term negative impacts to a financial plan.
In a worst-case scenario, what if your company goes bankrupt? There are plenty of examples from every industry remember Enron, Bear Stearns… I remember when the pinnacle of good credit was having a Sears card. In today’s Covid-19 world, the list of major companies with strong brands going bankrupt continues to grow. Having all your investments tied up in one company and the stock value plummets to zero, that is not just a nightmare, but one that could unfortunately be a reality?
On top of losing all your investments, you realize that your job, your healthcare, and all other benefits you had are now gone as well. Unfortunately, many people believe they are immune to this happening to them. Personally, I do not think it is worth the risk to find out.
A large corporation can create a level of comfort and stability in a person’s life that makes it almost natural to want to invest a large percentage into that company. Having an understanding of the day to day operations of a company make investing in company stock more natural to the point where even the thought of investing hard earned money into some other company or investment vehicle could be quite stressful.
When faced with the decision to invest in something comfortable as opposed to the stress one may feel when trying to research and understand other potential investments, it is the same as conflict avoidance. Unfortunately, that conflict avoidance/comfortable decision may be providing yourself with a false sense of security.
There are many reasons why clients do not want to sell their company stock. Sometimes it is an emotional connection to the company or even the frustration they feel for having to pay higher taxes. The downside of making a lot of money could be paying a lot of taxes.
Finally, I see many clients who believe that since the stock has performed well historically, it will continue to perform well. Most of the time, there is no detailed analysis done on the company, but rather the comfort emotions coming back in to play. When seeing a higher balance year after year, a steady paycheck, medical benefits, vacation time etc. why would there be any reason to doubt that the comfort won’t continue?
One thing we do know is that past performance is not predictive of future performance. As I mentioned above, finding out the hard way is a not worth the risk because things can happen quickly and have lasting impacts. Prior to Covid-19, Hertz Rental cars was one of the largest rental car companies. Their stock was over $20 in February 2020. After being up nearly 28% from Jan 1, 2020 through its peak in February. 3 months later, the company is filing for bankruptcy and their stock is at $1.00. It wasn’t years of decline, it was weeks.
Some companies will provide a 401K match in the form of company stock and for those that climb higher on the corporate ladder, it’s not uncommon to receive restricted stock or stock options. As you continue to receive all of these shares, it’s likely that the percentage of your net worth that is tied to your company stock will continue to rise.
Now what? You want to be prudent and maintain a reasonable allocation to your company stock, but you keep getting more and more exposure to it. In some cases, such as stock options or restricted stock, you can’t sell and diversify for a period of time.
When you find yourself in this scenario, you may want to consider several options that may help increase your diversification while you wait for the opportunity to sell and reallocate.
– PLAN!! – Run through a detailed financial analysis to determine the appropriate amount of stock you should have. Run your financial goals through a stress test to ensure that you do not expose your goals to more risk than needed.
– Stop buying company shares on your own. – It’s possible that you’re buying shares through an employee stock purchase plan, an investment account, or via your 401(k) plan. If your total exposure in company stock is more than your financial plan calls for you may want to stop buying it where you have control.
For most people, the biggest goal they are saving for is retirement. That is the reason they accumulate as much money as possible. When it comes to one single holding in a portfolio, it is important to keep emotions in check and think about the bigger picture.
I often ask clients, “What scenario would you rather have in retirement… Beat the S&P 500 by 5% per year, or never have to worry about money again?”
9 out of 10 times, all that matters is the ability to retire without having to stress about money. The fear of running out of money is the number on fear for retirees. So when thinking about how much money to allocate to company stock, it is important to look at not just the upside, but the downside.
Once all of the planning has been done (the budget for retirement has been determined, the asset allocation has been put in place, and the rate of return needed to not run out of money has been analyzed). For the majority of clients I speak to, that is all that matters. For many retirees, if their portfolio goes up by 35%, their lifestyle is not going to change. They are not going to go out and make frivolous purchases just because they have more money in their investment accounts. On the other hand, if their portfolio goes down by 35%, the shift in spending needed to maintain a long term successful retirement is likely to change and the stress that will be felt on an emotional level will make it challenging to enjoy the retirement they worked decades to achieve.
Analyze and plan! Analyze the purpose of your money. Why are you saving? Is it for retirement, college for a child or grandchild, a major purchase? Then analyze your current asset allocation and determine how much of your money is tied up in company stock. You may want to also evaluate how much stock you expect to receive in the future as part of your compensation package.
Next, you should evaluate your risk tolerance, your time horizon, and your goals to determine whether your allocation is appropriate.
Finally, I would recommend that you develop a plan to maintain an appropriate level of company stock needed to achieve the goals you have set with as little risk as possible.
If you are trying to figure out where to start, let one of our advisors help. We believe that it is important for every investor to have access to detailed financial planning. That is why right now we are providing comprehensive planning at no cost. We will run through a detailed analysis of your complete financial picture while running your portfolio through a number of stress tests to make sure that you are positioned properly. Please use the link below to get started on your analysis today.
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