Why Now Is a Smart Time to Sell Company Stock
A stubborn portion of 401(k) savers have too much riding on a single stock, putting their retirement at risk
Diversification is one of the few investing principles that is easy to grasp. Owning a bunch of different investments reduces the risk that a portfolio will be laid low by bad news in one type of asset or one industry. Or, riskiest of all, one stock.
If you own an index fund or exchange-traded fund (ETF) that tracks the S&P 500, you’re diversified across 500 stocks. Apple and Microsoft recently were the two largest chunks of the index, with each accounting for about 4.5% of the total index. If you own a broader “total market” stock index fund, those two stocks each account for less than 4% of the index.
There’s no single, hard-and-fast rule on how much of one stock is too much, but keeping any single stock to 5% or so of your investment portfolio is considered prudent. Once you get to 10% or more riding on one stock, you’ve taken a deep dive into the risky pool.
Yet plenty of retirement investors are doing just that. According to the latest annual survey by the Plan Sponsor Council of America, in 2018 more than half of plans that offered company stock had an average of 10% or more of total plan assets riding on that stock.
Vanguard, a major administrator of 401(k) plans, reported that in 2018, among plan participants who had the company stock as an investment option, one in five had more than 20% riding on that single stock.
Granted, the company-stock risk lurking in 401(k) plans has dissipated over the past decade or so.
In 2007, one in three plan participants had at least 20% invested in their employer’s stock, according to Vanguard. The smart shift away from overloading on company stock was the logical outcome after epic 401(k) debacles raised investor awareness to the risk and pushed Congress to pass new regulations that made it less common for companies to encourage overinvesting in company stock.
The most infamous 401(k) meltdown came with the collapse of Enron due to massive accounting fraud, masterfully dissected in the best-selling book and documentary film “The Smartest Guys in the Room.”
In late 2000, Enron stock hit an all-time high of more than $90 a share, and at year-end, 62% of the firm’s retirement plan was invested in Enron stock. A year later the company had filed for bankruptcy, and the stock traded for less than 30 cents a share.
In 2002 a similar implosion hit WorldCom employees, who reportedly had about 40% of their retirement money invested in their employer’s stock before it declared bankruptcy.
Though fraud-induced bankruptcy is an outlier event, the fact remains that a big investment in a single stock leaves you massively exposed to a laundry list of more run-of-the-mill risks: Bear markets happen. Disruption happens — a lot. Global trade wars happen.
To have your retirement security riding on any one stock is just flat out risky. And it’s even worse if that stock happens to be your employer. Entertain the thought, just for a moment, of what would happen if really bad news hit your firm. Maybe it’s a sector implosion that you get caught in, and not even something directly tied to your company’s operations. Not only would the stock drop, you could lose your job. Overinvesting in your employer’s stock is doubling down on job-related risk. Got stock options? You are tripling down.
For a small portion of plans, company policy is partly to blame. Back in the day (the 20th century) it was very common for employers to make their matching contribution only in company stock. Moreover, many plans forced participants to keep the stock, not allowing them to move it into a more diversified mutual fund offered in the plan. Thankfully that is no longer the norm. Congress passed legislation in 2006 that made it easier for employees to get out of company stock even when it’s how they are “paid” their matching contribution. And fewer companies use their own stock as the match these days.
Interestingly, Vanguard noted in its 2019 annual review of plan data that firms that still use company stock for the matching contribution seem to implicitly encourage workers to own more stock. Plans that offer company stock but didn’t use it to match, had an average of 11% of plan assets in the firm’s stock in 2018. In plans that made the matching contribution in company stock, an average of 23% of plan assets were invested in the single stock.
If you’ve got plenty riding on company stock, now is a bit of a sweet spot for taking diversification more seriously. More than 10 years into a bull market — and with new highs being reached in mid-January — gives you the opportunity to trim an over-bet on company stock and sell high. Could it go higher? Of course. Then again, it could just as easily fall too.