Company Men
CBO Director Peter Orszag reports on very poor decision-making about Americans’ retirement portfolios:
Despite those risks (again, for which workers don’t receive higher expected returns on their investments, on average), a significant number of 401(k) participants hold the bulk of their assets in company stock. According to calculations by the Employee Benefits Research Institute, 47 percent of 401(k) participants were enrolled in plans that offered company stock as an option as of the end of 2006. Of those participants, 7.3 percent held more than 90 percent of their assets in company stock, and over 15 percent held over half their assets in company stock. (See page 33 of EBRI Issue Brief 308, “401(k) Asset Allocation, Account Balances, and Loan Activity in 2006.”) At yesterday’s hearing, I didn’t make clear that the 7.3 percent figure applied only to those who were in plans offering company stock. So the overall share of 401(k) participants with 90 percent or more of their assets invested in company stock is more like .47*7.3=3.4 percent. It’s still too high.
And to be clear, 3.4 percent is too high because the correct proportion of 401(k) participants with 90 percent or more of their assets invested in company stock is zero. Nobody with any choice in the matter should be nearly that heavily invested in any one company. And under normal circumstances, it’s especially pernicious to be heavily invested in the company you work for. That means that if your stock goes bust, it’s probably a situation where you’re likely to lose your job as well.
The only places I’ve ever worked for have been either privately held firms (The Atlantic) or non-profits (TAP, CAP) so I haven’t personally experienced this problem, but I’m told that at a lot of firms there’s substantial informal and semi-formal social pressure to be heavily invested in the employing firm. Maybe not so many people go as far as 90 percent, but 90 percent is absurdly too high anyway. You’d do a lot of good for a lot of people if you found a way to break that habit.
37 Responses to “Company Men”
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October 19th, 2008 at 9:27 am
In our 401K the company gives their match and bonuses in company shares and they don’t allow you to change it.
October 19th, 2008 at 10:13 am
“Nobody” is not quite correct.
A few years ago Bill Gates had over 90% of his net worth in Microsoft stock.
He also had about $5,000,000,000 in US Treasury notes.
If I had too much company stock in my 401k then I would buy puts outside of my 401k to protect myself. Of course, if I had even a billion in T Bills then I might not worry too much about the price of my company stock.
October 19th, 2008 at 10:23 am
I don’t know how realistic it is to expect average people to have the time and expertise to properly manage an investment portfolio. I believe we’ll come to regard the widespread swap of defined benefit plans for 401Ks over the last few decades as a very bad deal for most Americans.
October 19th, 2008 at 10:43 am
“And under normal circumstances, it’s especially pernicious to be heavily invested in the company you work for. That means that if your stock goes bust, it’s probably a situation where you’re likely to lose your job as well.”
This isn’t correct.
Of course it’s bad to be heavily invested in your employer’s stock if you’re not paying attention to your investment and willing to disinvest, if necessary. But assuming you’re able to be reasonably rational about the situation, and can resist peer/employer pressure to stay invested when things are looking bad, then investing in your employer’s stock is one of the very best places an everyday individual can invest.
Why? Because unlike the case with most other companies, you actually have deep knowledge about both the long-term and short-term prospects of your company. Obviously, there’s a legal limit to this—if your information is considered “insider”, then you absolutely shouldn’t be actively trading in your company’s stock. But if you’re intelligent and well-informed and low-level enough such that insider knowledge isn’t a consideration, then you’re far more likely to make good decisions with your company’s stock than elsewhere.
That was my experience when I had large investments in my employer’s company during the dotcom era. All of what I wrote above was proven true in my personal experience, including the warnings. On the down side, I left a large quantity of money invested in stock from options I exercised and held during the period of the dotcom bust…holding on to it at the beginning hoping the bottom had been reached; and holding on to it after that because I couldn’t stomach realizing such large losses (and thus allowed them to increase). So, being irrational is a big problem.
On the other hand, I did some very successful day-trading with my employer’s stock, along with some of our competitors, simply because I knew both how these businesses were performing as well as having extreme experience watching how these stocks traded on a daily basis, especially my own employer’s. I once made 20K in two weeks because I correctly realized that my employer’s stock was trading too high and our competitor’s too low, and moved it from one to the other at almost exactly the respective highs and lows simply because I had all the relevant experience and information. That was my most successful short-term trade of my company’s stock, but there were almost a dozen trades like this.
My impression at the end of this experience is that the only people who can successfully day-trade are those with extensive experience in how a company trades on a daily basis as well as large amounts of experience and information about the company’s actual business (so as to avoid merely following other day traders as the stock takes its random walk). I think that technical investing is a load of hooey—so only this combination of deep experience with how a company trades along with deep knowledge of the company’s business fundamentals is it possible to do what so many people attempt to do, and fail.
What is true at the day trading level is also, somewhat, true on the long-term investment basis, with the exception of needing to know how the company trades, short-term. If you work there, you know how the business really is performing; assuming you are intelligent and pay attention. You’re far more likely to correctly identify when the stock is likely to perform well and when it is likely to perform poorly than people who know less about the company. Of course you should take advantage of that knowledge. But, again, you have to be rational and resistant to outside pressure to hold on to an investment that you know to be bad. If these things are true, you’ll never find yourself in the situation Matt describes—losing your job and losing your shirt. You should have disinvested before the layoffs occurred. Rarely is something like that completely unexpected by the employees.
October 19th, 2008 at 10:43 am
By my understanding, the company which offers the 401k program has substantial (if not total) control of the set of available investment options for plan contributors. It wouldn’t surprise me if a number of them actually don’t offer many choices but company stock.
I haven’t really looked into this (my company gives me lots of choices, and matches contributions to boot), but that’s what I’m given to understand.
October 19th, 2008 at 10:49 am
I did some very successful day-trading with my employer’s stock, along with some of our competitors, simply because I knew both how these businesses were performing as well as having extreme experience watching how these stocks traded on a daily basis, especially my own employer’s.
It’s a good point in general, but misses the fact that you shouldn’t be day trading with your 401k money.
October 19th, 2008 at 11:18 am
“It’s a good point in general, but misses the fact that you shouldn’t be day trading with your 401k money.”
Agreed. I should have made that clear.
October 19th, 2008 at 11:20 am
Many companies contribute your company match in the form of company stock. And many companies today are contributing at least 1-2% into a 401k, even if you don’t contribute your own money.
That’s the ONLY time I’ve ever seen a 401k which allows you to invest in a single stock. Otherwise they’re choices of mutual funds.
What these statistics are showing is the number of people who never go into their 401k and move money around.
October 19th, 2008 at 11:21 am
Keith, here’s what I don’t get about your post. Essentially, the underlying premise is that the insider trading rules are not broad enough. In other words, there are non-insider employees such as yourself who know more about the company’s prospects than the professional analysts rating the company.
Its possible this is true for smaller companies which are not very well vetted. But for a large firm, with billions of dollars riding on its stock, I’d assume Wall St throws enormous resources to obtain every bit of material information it can about the stock.
Anyone out there know something about this?
October 19th, 2008 at 11:23 am
Also, perhaps companies can pressure you into *putting* your contributions into company stock but how can they pressure you into *keeping* it in stock? I assume they can’t look into your 401k account, right? How will they know if you rebalance your portfolio?
Or is it just employer matches we’re talking about?
October 19th, 2008 at 11:26 am
One more thing. The first politician who proposes a bill which allows me to rollover my 401k money into an IRA without me having to quit the company… get’s my undying love and affection.
If John McCain proposes this tomorrow, I’d abandon Obama and support his campaign even though everything else he stands for is wrong and disasterous. It’s that important to me.
Same with healthcare plans. My fiance and I are getting married. We’re talking about healthcare plans… do we pick a family plan on hers, or mine, etc. Her company has a better plan then mine. Then she mentions she might get laid off. Well think about that. Let’s say we did choose her plan, and she got laid off half way through.
I would not be able to walk into our HR in June and say “I need insurance”. It’s not allowed. If you don’t sign up in January, you can’t change later on. We’d be completely and uttery fudged.
That’s one of the few things I do find McCain is good on… disconnecting healthcare from employer. That isn’t enough for me to vote for him, but like I said if he also did the same with 401k… I’d back him 100%.
October 19th, 2008 at 11:27 am
If I had too much company stock in my 401k then I would buy puts outside of my 401k to protect myself. Of course, if I had even a billion in T Bills then I might not worry too much about the price of my company stock.
This is always the sort of thing I’ve wanted to do. For example, if your options are underwater and expiring soon, why not sell the equivalent calls? The problem is that if you get a margin call, you’d better be able to exercise the corresponding option quickly. And that actually becomes a problem that you have to deal with.
If your company is giving you 401(k) match in company stock, that’s just something to take into account when considering your other employment options.
October 19th, 2008 at 11:28 am
DJ – I believe we’re talking about people who never touch their 401k.
I know until say 2000 or so mine wasn’t available online. For me to rebalance my 401k meant an extensive amount of paperwork filed with our HR dept. It was a lot of work.
As such, I never did anything.
October 19th, 2008 at 11:29 am
It’s a good point in general, but misses the fact that you shouldn’t be day trading with your 401k money.
Actually, if you’re day trading at all (which I wouldn’t advise, but can be done profitably), this is by far the best way to do it.
October 19th, 2008 at 11:42 am
Whoa, there, that can’t be right. I’m pretty sure losing your existing health coverage counts as a qualifying event. Else it’ll undermine my faith in the maxim that American regulations generally end up in a sensible form, unless interest groups conspire to keep them messed up.
(As opposed to? As opposed to places where things stay messed up because they’ve always been that way and nobody bothers).
October 19th, 2008 at 11:42 am
“Essentially, the underlying premise is that the insider trading rules are not broad enough. In other words, there are non-insider employees such as yourself who know more about the company’s prospects than the professional analysts rating the company.”
But not because I knew things that were not, in principle, unavailable to other investors. Obviously there’s a gray area in this; but I believe that insofar as my knowledge of our business and that of our competitors mattered, it mattered because I was very keenly paying attention and not because I knew things that non-employees did not.
I think that non-employees would have had to work very, very hard to be as aware of the business fundamentals as I was. I think this is true for most stocks. I mean, really, don’t you think that the overwhelming number of investors, including institutional investors, actually know very little and pay attention almost exclusively to analysts’ opinions, the company’s earnings statements and PR, and its trading trends? Few even bother at all to research a company in any depth, much fewer to the degree to which an employee does simply by virtue of working there.
If pretty much everyone who works at a decent sized company knows that this quarter’s sales have been poor, I’m pretty sure that this doesn’t qualify as “insider information”. It’s too widely known, there’s no way it’s not actually publicly available outside the company. But it will be difficult for, say, someone working in another industry and who isn’t a professional trader to be aware of this.
October 19th, 2008 at 11:51 am
DJ is correct here. If you lose your existing health insurance in the middle of the plan year, it’s a qualifying event for becoming a participant in your own company’s plan, even though it’s not the normal enrollment time. Getting married and having a child are also qualifying events. I was on my husband’s plan through work several years ago, and when he was laid off in 2002, we were able to switch to my company’s plan, even though it was the middle of the year.
October 19th, 2008 at 12:08 pm
“Apsalar”
Very obscure reference in your nick; but cool.
I should be clear that I never traded my company’s stock, buy or sell, on the basis of any specific piece of information. It was more like gestalt information—it seems to me that if stuff like this and general info that low-level employees know are included as “insider information”, then pretty much no one would be able to buy or sell their employer’s stock under any circumstances. That’s clearly not the case.
October 19th, 2008 at 2:31 pm
This is why we have government: to mandate by law things that are (a) obviously correct and (b) hard to do on an individual level because of local pressures and sanctions.
October 19th, 2008 at 3:00 pm
It’s a good point in general, but misses the fact that you shouldn’t be day trading with your 401k money.
If you successfully day-trade, you’re going to generate taxable capital gains, a lot more capital gains than through an equally successful buy-and-hold strategy. So successful day trading absolutely be done in a tax-sheltered 401K.
Of course this only applies to day-trading where you make at least some money, and since 90% of people lose money when day-trading…
October 19th, 2008 at 5:42 pm
Hi,
In my home town I happened to work for several years (at a large gas transmission company as a contract software developer. I knew the company had several billions of dollars in infrastructure – giant (1988-91), compressor stations, gas fields in the Gulf of Mexico, etc. In the 70s they entered into many so-called take-or-pay contracts with gas producers because it looked like the price of gas was destined to go one way – up.
But then they went down, and the Gas Transmission company had to take high-priced gas, or pay for it anyway. They squirmed around for a while trying to renegotiate those contracts, and the gas producers said no thanks, just keep on writing us those big checks.
Well, having really good lawyers on staff, they determined that they could break those contracts unilaterally in only one way – they declared bankruptcy. Paying those take-or-pay contracts was going to break them, they swore.
I was already moved on to another job, but I knew they had huge capitol investments on their books, as anyone could know from their annual report. Their stock was at $45 or so in the morning, and around $14 by dinner time. My broker told me that she had many retirees fully invested in this company’s stock, and most of them sold at 10 or 15% of their real investment.
Not understanding that you don’t suffer a loss until you sell. Or they go out of business, which is what they feared, of course.
Not very smart, keeping all your eggs in one basket! Still true, if you don’t sell, you can’t lose money, unless they go out of business. Something to keep in mind in today’s market, for sure.
JR
Oh, yes, once those take-or-pay contracts were broken, somehow they managed to return to profitability, and later they were bought up, at much more than $14 or so a share. Much, much more. I wish I’d told my broker to buy some at $14…! But they were really afraid to recommend anything
“contrarian!>
October 20th, 2008 at 12:31 am
The criticism of employees for holding company stock isn’t really very logical unless you add in some other information:
How many other assets do these employees hold? If they’re saving 1% of their income in 401k company stock and 40% in a diversified portfolio outside the 401k, they’re not really taking an undue risk, are they?
How well do these employees understand the profitability and pricing of their company stock? If the company actually is performing fantastically and the stock is available cheaply, how is it wrong to invest in the company one knows best?
To what extent does employee stock ownership align interests between management, workers, and non-affiliated shareholders? If you own part of a company, wouldn’t you prefer to see that the people who work there share your stake in the company’s profitability?
More broadly, if “company stock in a 401k” were presented as “an employee-owned company where the workers share in profits”, Matt and many commenters would be covering it in praise. The two situations are the same thing. Decieving and terrifying present markets aside, the stock markets are not simply risky casinos in which people with no clue lose all their money; they’re a mechanism for sharing ownership and resultant profits. If you would prefer feudalism, communism, or an even more oligarchic capitalist democracy, go ahead and make your argument.
October 20th, 2008 at 2:34 am
I was with a firm that matched my 401(k) contributions, up to 3 percent of my income, with company stock. So even when I directed none of my contributions to purchase of company stock, its share of my portfolio was overweighted. And this kicker: Under rules of the plan, I could redirect only 25 percent of that company stock to other investment options each quarter; and to do so, I had to go through lengthy rigamarole on the telephone with the investment management firm. I put myself through three or four aggravating phone calls each year; a lot of my colleagues did not.
October 20th, 2008 at 3:13 am
On the other hand, owning stock in a company where you are a manager helps align your self-interest with your shareholders. For corporate officers of publicly traded companies, I’d like to see some system where they have to invest in their own firm’s stock with no ability to sell in less than, say, ten years. This would give them more incentive to do right by shareholders in the long term rather than follow pump and dump get rich quick scheme. As we’ve seen with Wall Street, paying out big bonuses annually in cash encourages decisionmakers to take on too much risk.
October 20th, 2008 at 11:37 am
“But assuming you’re able to be reasonably rational about the situation, and can resist peer/employer pressure to stay invested when things are looking bad, then investing in your employer’s stock is one of the very best places an everyday individual can invest.”
No, at least for the ordinary worker bee. You need to diversify to decrease risk. Your employment is tied to your employer. If you invest in your employer, then your wealth as well as your income is tied to them. Great when they’re doing well, but disastrous if/when things go south.
“On the other hand, I did some very successful day-trading with my employer’s stock, along with some of our competitors, simply because I knew both how these businesses were performing as well as having extreme experience watching how these stocks traded on a daily basis, especially my own employer’s.”
Keith, what you’re talking about is very close to insider trading. If you had access to internal financials, it probably was insider trading. This is not something to brag about, or to encourage ordinary worker bees to start doing.
October 20th, 2008 at 11:41 am
“As we’ve seen with Wall Street, paying out big bonuses annually in cash encourages decisionmakers to take on too much risk.”
Bonuses in cash are not as bad, in terms of encouraging risktaking, as bonuses in stock options. The value of options increase with volatility; so having the company taking on more risk is a rational self-interested response if a large chunk of one’s compensation is in options.
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