Stock in Your Employer
OUR CONCERNS ABOUT OWNING STOCK IN YOUR EMPLOYER
A common theme among portfolios brought to us for review is the concentration of employer stock, especially in 401(k)’s. For approximately five million investors in the United States, 60% of their retirement plan is in their employer’s stock. And for all those whose 401(k) plans allow, almost ten percent have more than 90% of their retirement plan in company stock.1 We usually recommend the sale of the employer stock to diversify based upon two factors:
- Market Risk – you are not rewarded for the risk of holding a concentration in a single stock. By diversifying, i.e. “not having all your eggs in one basket”, you can significantly lower the risk of your portfolio.
- Company Risk – your single largest asset is, in a sense, your salary. If your company does poorly, chances are your salary will not greatly increase, if not disappear in a layoff. Employees of Enron who invested solely in the company stock not only lost their jobs but their retirement savings as well.
Even with these reasons, which are widely accepted in the financial planning industry, it is hard to convince investors to divest. And the problem is as prevalent among “sophisticated” investors as the general public. Twenty-seven percent of the funds invested in Merrill Lynch’s 401(k) are in shares of Merrill Lynch.
2Jason Zweig examines in his book Your Money and Your Brain underlying neurologicalreasons for employer stock concentration. Zweig, a senior editor for Money magazine, has written a book destined to be a classic. In his chapter on “Confidence”, he discusses “the eerie power of mere exposure.” Zweig examines research which shows “being in the presence of familiar things (even when we are unaware of them) simply makes us feel better.”3He claims that current research proves Aesop had it all wrong with his saying “familiarity breeds contempt.” Familiarity in fact breeds contentment. This “familiarity” phenomenon may partly be explained because certain brain cells are dedicated to familiar objects firing upon encountering the object. This “firing” generates a feeling of comfort.
In addition as humans, we continually attempt to control our environment. Our jobs give us a feeling of control, as if our efforts will have a profound effect on the success of the company. In reality, even a CEO is subject to numerous factors beyond his control. Any “inside” knowledge we may have about our employer, especially a large one, pales in comparison to the risk that we may be wrong.
Zweig also addresses the feeling of regret that comes from selling an investment. “The investments we own tend to seem better to us than those we don’t own….”4The potential rise in price after we sell a position is simply too painful for many to bear. Lockheed Martin is a good example of the result of the fear of regret. As Lockheed matches 401(k) contributions with company stock, many allow positions to build up rather than diversify. Obviously inertia also plays a large part for the holding of the positions.
Zweig references a survey indicating that it is much harder to sell than buy a stock. “People know perfectly well that a good decision takes more work and more thought, therefore they sweep it under the rug.”5It is simply easier to hold a position than make the mental effort to sell.
A concentration of any stock, but especially your employer’s, can place undue risk on your portfolio. Many experts recommend that you hold no more than 10% of your portfolio in any one stock. We wonder if even this percentage is too large. Divesting of a concentrated position should be one of the easiest investing decisions. But as shown, our brain can be one of our worst enemies.
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