Investing in your own employer seems like a no-brainer. Whether through options, restricted stock, or common stock purchase plans, why wouldn't you buy in? But the decision's not as obvious as it may seem, and loading up on your own company's shares could produce as much pain as profit. Before you decide, make sure you know all the pros and cons.
Don't know much about employee stock plans? You're not alone. The folks at Fidelity Investments recently studied nearly 2,000 stock plan participants at 130 companies around the globe, discovering a few surprising facts:
- 35% of respondents didn't understand the tax implications of selling their stock.
- 10% confessed to not researching their investments.
- Company stock plans were participants' second-biggest savings vehicle; 401(k)s were the biggest, by far.
- Only 52% could "generally" explain their plan, and 11% couldn't explain it "at all."
According to the National Center for Employee Ownership, tens of millions of employees participate in thousands of different stock-related plans, so this is definitely not an obscure issue.
Know the rules
Clearly, it's important to know how your available investments work -- and I'm not just talking about stock plans. Many people don't understand or fully employ even simpler, more common vehicles such as IRAs. They don't appreciate that money parked in Roth IRAs for decades may ultimately be withdrawn tax-free, and they often don't get around to making annual contributions before the deadline passes.
Stock options also have a finite window. You typically must exercise them within a certain number of years, and if you leave a job, you may only have a few days or months in which to exercise stock options. There are also major tax issues involved; in some cases, simply exercising a stock option, without promptly selling the stock you receive, can trigger an unexpected and potentially sizable tax hit.
Diversify sufficiently
More importantly, employees who sink the bulk of their savings into their own company's stock become dangerously undiverisifed. It's easy to make a good case for investing in your employer; it's the company you know best. But that doesn't mean you know everything about it.
If you worked for Chimera Investment (NYSE: CIM ) , you might be familiar with how it makes money investing in mortgages, and you'd probably know and trust its management. However, you might not realize that if interest rates rise -- as they surely will -- the company's profitability will likely fall. You might also not know that Chimera specializes in riskier mortgages than other mortgage REITs.
Similarly, workers for Rare Element Resources (AMEX: REE ) might know its day-to-day operations, yet not be aware that the company has been diluting the value of existing shares by issuing numerous new ones to raise money.
Even if you have researched your employer, you could still end up blindsided. Enron employees lost more than $1 billion in their retirement plans when the company's fraud came to light. The BP (NYSE: BP ) Deepwater oil disaster gave BP shareholders a big haircut in short order; even now, the oil company's dividend is just half of what it was.
Overloaded baskets
Even if your company stock amounts to "just" 25% of your entire nest egg, keep in mind that much or all of your current livelihood also depends on that same company. If it falls on hard times, you could face a double whammy: a pink slip and a sinking stock.
A glance through Brightscope.com's reports on familiar companies shows that investors have devoted considerable chunks of company 401(k) plans to their employers' stock. At Sirius XM Radio (Nasdaq: SIRI ) , company stock represents 13% of investors' 401(k) holdings. That may not seem like much, but Sirius XM still faces significant debt and steep challenges from Pandora's (NYSE: P ) Internet radio.
Corning's (NYSE: GLW ) 401(k) plan has 25% of its plan assets in company stock. Even with the company's strong position in specialty glasses and ceramics, and relatively low valuation, that still might not be a smart move for employees.
The Wells Fargo (NYSE: WFC ) plan has a whopping 37% in company stock, and some employees may have far higher percentages in their particular accounts. These Wells workers may have forgotten that in 2008 and 2009 , the stock price fell from around $40 to close to $8. The company is not without risks, and having made regrettable mortgage loans in the past, it isn't immune from future dumb moves.
The big picture
Buying your company's stock isn't necessarily stupid. It can still make particular sense to buy company stock if you're getting your shares at a discount.
But to preserve your best odds of retiring rich, be sure to consider your financial big picture. Make sure you're comfortable with the percentage of your overall assets and income invested in your employer. And as with any other investment, keep on top of your company's progress and health.
For great stock ideas, read this free report from The Motley Fool to find the names of five stocks we own that you should, too.
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