Our friends at the National Association of Securities Dealers are looking out for us again. They recently issued an "Investor Alert" about a common problem with 401(k) plans: "Putting Too Much Stock in Your Company."
They have a good point. We all know the old warning about putting too many eggs in one basket. Well, that's exactly what you're doing if you're routinely plunking much of your savings into the stock of your employer, often through good intentions and a 401(k) plan. You're actually putting too many of your nest eggs in that basket. (Learn more about 401(k) plans and how to make the most of them.)
NASD prefaced its statement with reminders about those poor Enron and WorldCom employees who lost so much of their retirement money. It then went on to say:
"NASD is issuing this Alert because it is concerned that employees who have the opportunity to invest in company stock may be concentrating too much of their retirement savings in a single security. NASD is particularly concerned about employees who have all or most of their 401(k) assets in their employer's stock. If the stock takes a beating, so does your retirement savings."
It points out that whereas traditional pension plans are restricted to investing no more than 10% of assets in the stock of the employer, 401(k) plans have no such limitations. Making matters worse, those wonderful and valuable matching contributions that many companies make to our 401(k) plans are often in the form of company stock.
There's an upside to investing in your employer, to be sure. After all, of all the companies out there in which you could invest, which one do you understand the best? Your employer, probably. You are most likely familiar with its challenges and initiatives and with how well the firm is executing its strategies. You probably have a sense of the character of management. These are all extremely valuable things, and you're right to act on them and invest in your firm if the information you have is promising.
But just remember that bad surprises do happen, and that's why it's smart to diversify. Enron, for example, had employees and financial analysts fooled.
NASD cited a study by the Employee Benefits Research Institute and the Investment Company Institute. The study reported that, among other things:
- "In the case of employees over the age of 60, almost 25% held more than half their 401(k) savings in their employer's stock."
- "Even more startling, 16% of employees over the age of 60 held more than 80% of their 401(k) savings in company stock."
So what does NASD recommend? It suggests that the maximum that you might invest in one firm is 10% to 20% of your portfolio.
Remember, it's not just a total meltdown like the Enron situation that you need to worry about. Even top-notch firms experience temporary downturns -- and if a prolonged downturn happens when you're retiring and need that money, you'll be in trouble. Consider Eastman Kodak (NYSE: EK ) , for example. In 2000, it was trading in the $60s per share. Today, it's in the $30s, after having dipped down to around $20 in 2003. Similarly, Pfizer (NYSE: PFE ) had been trading in the $40s per share for most of 2000 and 2001 but has recently been trading in the $20s. Coca-Cola (NYSE: KO ) shares have not been much more impressive over the past few years.
Are these firms hopeless? Hardly. But if you've pinned 50% or more of your retirement on them, you may regret it.
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Longtime Fool contributor Selena Maranjian owns shares of Pfizer and Coca-Cola. The Fool has a disclosure policy.