Your single dumbest 401k move
Piling up stock in the company you work for is just doubling down on risk -- potentially making you a two-time loser.
This post comes from Brett Arends at partner site SmartMoney.
There are plenty of stupid investments you can make in this world. Stock in Pets.com and Washington Mutual didn't work out so well. Nor did those Las Vegas condos. Some of the social media and Web 2.0 stocks flying high on Wall Street will probably follow suit. But the most foolish investment of all may be right in front of you. And there's a worrying chance you're buying it.
The investment? Stock in your own employer.
Late last year the Employee Benefits Research Institute, a think tank, published its most recent study of 401k retirement plans. The good news is that employees overall cut their exposure to their employers' stock; it accounted for only 8% of all 401k assets in 2010, continuing a downward trend that goes back to 1999, reported EBRI's Jack VanDerhei and colleagues.
The fine print isn't quite so good, it turns out. According to EBRI's data, only about 40% of 401k plans even offer the company's stock as an option. Employees in those plans are still investing from 16% to 19% of their plan portfolios, on average, in their employer's stock. At the same time, they have been shrinking their overall equity exposure dramatically. For those employees, company stock accounts, remarkably, for about a third of their entire equity exposure in the plan.
One dollar in your employer for each two dollars spread across all the other companies out there? It makes no sense. (Post continues below.)
But isn't it a good idea for employees to own a piece of the firm? Doesn't it incentivize them to work for the good of the company, to create value and put stockholders first? Phooey. This is what you hear, but it's little better than Orwellian propaganda. None of it stacks up.
Let's look at the flaws: First, you already have a big investment in your employer. You work there. If you are hoping to work there for some time, it may well be the biggest investment in your portfolio.
The value of an investment comes from its cash flow. Let's say you're hoping to earn a modest $45,000 a year for the next 10 years. An annuity producing that series of cash flows might cost you about $380,000. For 20 years: nearly $600,000.
No, a job and an annuity aren't identical -- annuities don't demand you work for the money. But the analogy is useful. Your cash flow already gives you a huge stake in the company. Do you need to double down?
Legions of workers did just that and became two-time losers. Their employer collapsed. They lost their incomes and their savings at the same time. Think of Enron. Think of WorldCom. Think of all those who worked at banks that collapsed in 2008. Bank of America and Citigroup avoided bankruptcy, but their stocks fell to pennies on the dollar.
In theory, at least, it would make more sense to bet against your employer -- or your entire industry -- than on it. That way, you're protected against an industrywide meltdown. Any Lehman Brothers staffers who bought "put" options on the banking industry, or default swaps that paid out if their company imploded, would have had a better 2008.
The second problem with investing in your own employer's stock? It's based on the theory that you'll benefit from the company's improved performance and that owning a stake in the company will give you an incentive to contribute. You'll be a stockholder as well as an employee, and you'll think like one, the theory goes. Employees buying company stock think they will have some influence over how it fares.
Good luck with that.
The theory's fine if you work for yourself, or in a small partnership. But in a company of 500 or 1,000? Dream on. No matter how hard you work, you won't have any material effect on the share price. The only individuals who can do that are the senior executives.
The CEO isn't buying it
Speaking of whom: Many people who buy company stock think they are following safely in the footsteps of top executives. But this, too, is an illusion. Even if the CEO holds $10 million in company stock, so what? His financial situation is totally different from yours. He may hold $50 million in other investments. If he gets canned, he may have a golden parachute and a network of golden handshakes to fall back on. So the "big bet" he's taking may not be what it seems.
And are CEOs really investing in the company? Most just get free stock and options -- which they then sell. Among top executives, stock "sales outweigh purchases by a substantial margin," says Lucian Bebchuk, a Harvard professor and a leading expert on executive pay. Most of them, he adds, "keep getting equity incentives as part of their compensation and they unload them over time."
Vickers Stock Research, which follows executive trades, says that over time, the amount of stock sold by U.S. executives outweighs the amount bought by more than two-to-one. Do you think they know something?
More on SmartMoney and MSN Money:
I'm happy to invest in my company stock which is offered at a 15% discount for employees. (Approx. 40% of my portfolio). One would be dumb NOT to buy it at that discount rate. Hasn't upset me yet... although I still have a 401 & a Roth. Who wouldn't want to make 15% on their investment right off the bat with potential for even more? It's worth the risk to me.
Any investment is a gamble, really. It's just how much of a gambler you are that will tell you to buy stocks or not. We all have different tolerances, desires, goals... Yes, my stock values may fluctuate, but overall growth has always been there. Sometimes one just has to have a little patience to wait out the no-growth/slow-growth periods.... & know when to sell (As Warren said, anytime you make money is a good time to sell!).
to delru - i'm sorry to hear about your experience but you can't blame your retirement account. retirement accounts get special tax benefits that allow your money to grow tax-free until you need to start using it for your retirement income, so your money will grow and your account value be worth more than if you just put it in a regular bank account. its good to have different accounts/plans for different things. If you have x-amount of money to save, think about putting some of it in a retirement account, some in an emergency savings accout, and if your husband is eligible (and you too), using a little bit of that money for disability insurance.
"Don't put all your eggs in one basket" except if that basket is labeled PROCTER and GAMBLE! My dad started working for P&G in 1928 and participated in their profit sharing plan. He and several of my uncles would most vehemently conradict your premise. I believe so strongly in the quality, integrity and endurance of P&G that I have established a Dividend Reinvestment Plan (DRIP) for each of my grandchildren. I fully expect that in 2028 they will look in the "basket" and be more than satisfied!
became independent in the 90's more or less. My husband's company stock skyrocketed and he took it out immediatedly and held on to it without increasing spending. I inherited a little from my Dad and splurged a little but also daytraded a bit with Microsoft (on the telephone). The kids were both top students and got lots of scholarship offers and we turned down name brands for the offers. Now I am having a nice time in my early sixties. House paid for by 55. Life is good. Go for it!!!
The dumbest mistake we ever made was even starting a retirement plan. We got up to $100K, then my husband got very sick for over 2 years. Even though I was working, it wasn't enough to pay all our mortgage, utilities, bills, etc. We had to withdraw from the plan several times to stay afloat - until it was all gone.
Between penalties and taxes, we only received about 60% to keep going. We didn't take vacations, buy boats, nor anything frivolous. Just survival mode. Looking back at the fluctuations in the market, and all the penalties assessed, we've learned...just take some funds and stick it into a bank account. Then your money will be there when you need it, and you won't have to withdraw retirement funds just to pay the taxes and penalties from when you had to withdraw the last time to pay your bills - knowing you'll wind up paying taxes and penalties AGAIN. Vicious circle.
The laws that are written don't allow for hardship exclusions, or reduced penalties to help you out. Sure, you won't get the pre-tax benefit, but at least whatever you save will be YOURS. Never, ever, again. My husband is back at work, now, and we put our savings into a regular, separate bank account. If another life-changing event happens, at least there will be no penalties and the IRS won't be banging at our door wanting blood from these turnips!
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