A news item caught my eye today. Yet again, employees are suing their own company (JP Morgan) for allowing them to buy company stock in their 401(k) plan while allegedly hiding known financial risks. This lawsuit is just plain silly, a by-product of the litigious nation we live in. Aside from the fact that their lawsuit has no merit (they really thought they should realize the upside benefit of equities investing with no downside risk???), there are several reasons why employees should simply NOT invest any of their 401(k) funds in their employer’s stock:
- Double Jeopardy – You already draw a salary from this company, and possibly restricted stock, options or other forms of long-term incentives. With your salary and/or bonus tied to the well-being of the company, why would you stack more risk on top of the biggest income risk you already have – your paycheck!?
- Market Efficiency (You’re No Smarter than the Market) – The market has already efficiently priced your company’s stock (here’s the Market Efficiency Argument). Sure, you have an emotional attachment to your company and you may think the stock’s really going to take off. I’ve been down that road and so have millions of other Americans. For every hot biotech or Apple-type company you can cite where investing retirement funds in the stock would have performed well, there are an equal number of complete duds that lost to the market. This is sheer random
- Lack of Diversification – If buying an individual stock in your IRA isn’t a good idea, why would it be in a 401(k)? There are plenty of broad-based index funds which can provide plenty of diversification.
- If Your REALLY Think Your Company is Great – (statistically, your company is just as likely to underperform the market as it is to outperform the market), but if you MUST own your company’s stock, why not just buy it in a separate trading account? Or better yet, if you’re that bullish and the market has underpriced the stock so much, why not just buy stock options in the open market? That would pay off way more than holding the stock itself.
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{ 9 comments… read them below or add one }
Good article and I mostly agree with you. I don’t know the details of the suit, but as a fiduciary JP Morgan might have liability here. Moreover in cases where the company match is in company stock and employees can’t diversify until age 50 I think this liability is very real.
As far as owning company stock I agree that “pigging out” on your own company stock is a formula for a real financial disaster (can you say Enron). However if you are going to own company stock in moderation (I generally say 10% would be the very max) your 401(k) is as good as anyplace. There is a technique called NUA (net unrealized appreciation) that can be used upon separation from service that can provide some real benefits with regard to company stock.
I’m curious about that NUA; does it somehow convey return benefits above and beyond non-stock investments?
For a great explanation of NUA check out this post by friend and fellow financial advisor Jim Blankenship. http://financialducksinarow.com/4576/net-unrealized-appreciation-treatment/ In my opinion any and all investments should be made based on the merit of the investment vehicle and how it fits with one’s overall financial plan. None the less this provision might be beneficial to some.
I have the option to enroll in a plan that lets me buy company stock at a discount quarterly but I don’t think I am going to participate. The main reason being what you listed above, I work for my employer so why put my eggs in the same basket. It would be a small percent of my total investments, but I think my job is enough of an investment in one place.
Ahhh, see that’s a situation to be envious of. If we make the presumption that markets are efficient and your company stock will perform roughly the same as the market in general, then by buying at a discount, it’s a guaranteed 5% additional return per year or whatever the discount is. If you can generate returns of 13% a year instead of 8% or whatever over a 30 year career, that sounds compelling. Not to sound like a hypocrite, but that might change the equation for me a bit to at least invest something!
I have bought a very small amount of company stock before as a way to introduce a little more risk in my portfolio, but I stress the very small amount. However, I assumed the investment was play money and expected to have loses. It actually worked out for me and I saw good returns.
I used to own some myself – mainly for the dividend since you can’t get dividend ETFs or funds in the plan for the most part. But over the last few years I’ve taken this stance.
I already own company stocks and options through grant and SPP. When I was younger, I purchased even more in my 401k. That was a dumb move and I lost a pretty sum during the dot com bubble so I learned my lesson. Now, I keep my company stock allocation to 5% at most.
I think there’s a serious danger of confirmation bias when you buy stock in a company you work for. If it’s good enough to work there, it HAS to be good enough to own, right?