This Could Be the Biggest Mistake You'll Ever Make

People may or may not learn from their own mistakes, but apparently, the idea that people learn from other folks' mistakes is a myth.

OK, maybe that's not fair, but it was hard for me to avoid coming to that conclusion when I was looking over an email from Fidelity's PR crew not long ago. Every quarter, Fidelity data-mines its 401(k) records and issues a little report on trends in 401(k)-land. And while Fidelity always -- of course -- puts its own corporate spin on things, its database of 11.2 million participants is big enough to be a pretty good indicator of what's going on out there.

There are a bunch of interesting data points in their most recent missive, but one in particular jumped out at me on first read: In the second quarter of 2009, 8% of dollars contributed to Fidelity-administered 401(k) plans went to the participant's employer's stock.

That may not sound like a lot, but it's enough to worry me -- lots of 401(k)s don't offer a company-stock option, so that 8% number is a lot higher among people who actually have the option. Haven't those folks been watching the news?

Too many eggs, not enough baskets
As far as I'm concerned, even if your employer pays the 401(k) match in company stock, holding it for the long haul is one of the biggest mistakes you can make with a retirement plan. The reason is pretty simple: Even if you don't own a single share of your employer's stock, your financial exposure to the company is already huge -- you work there! So, take advantage of the matching plan, but sell the stock off in order to keep it a very small part of your overall portfolio.

Holding your company's stock often doesn't look like a mistake to folks until it's too late. In fact, it might seem like a really good idea, especially if you work at a blue-chip like Chesapeake Energy (NYSE: CHK) or Pfizer (NYSE: PFE). After all, the odds that those companies will go the way of Enron seem really low.

Of course, that's what the folks at Bear Stearns said.

In all seriousness, I don't think either of those companies is going away anytime soon. (In fact, I think there's a decent case to be made for buying both of those stocks right now.) But that doesn't mean betting your future on their stock price is a good plan. After all, plenty of big names have seen big drops since the S&P 500 peaked on October 9, 2007, the recent rally notwithstanding -- and in many cases, their employees' 401(k) balances got clobbered as well:

Sources: Yahoo! Finance, Brightscope.com. Data from 10/9/07 to 9/17/09, adjusted for dividends and splits.

For comparison, the 401(k) stalwart Vanguard 500 Index Fund (VFINX) is down about 30% over the same period, but with a little work, it's not hard to outperform the S&P 500 over time while staying well diversified.

But most of those stocks will come back!
Maybe so. But imagine if you'd been working for Chesapeake for the last 15 years and investing the majority of your retirement savings in Chesapeake stock. You would have been feeling pretty good about things -- until the past year or so.

Now imagine that you're retiring in a month. See, this is where even great companies' stocks can end up being a retirement disaster -- because even great companies hit rough patches. And sometimes not even a dramatic comeback will save you. Take Wells Fargo (NYSE: WFC), where 43% of 401(k) assets are invested in the company's stock. The stock price has been going gangbusters since its lows in early March, but it's still down more than 33% from its 52-week high as I write this. That's a big chunk of savings -- gone.

And if you'd been investing all of your 401(k) contributions in Wells Fargo stock every month for the past 15 or 20 years, and you were looking to retire soon, you'd probably be pretty unhappy with the overall performance of your portfolio. When there are so many great stocks out there, are you really willing to bet your future on your employer's?

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This article was originally published on August 14, 2009. It has been updated.

Fool contributor John Rosevear has no position in the companies mentioned. Chesapeake Energy, Nokia, and Pfizer are Motley Fool Inside Value recommendations. The Fool owns shares of Chesapeake Energy. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy.