What Not To Do With Your Retirement Nest Egg

In my view, equities are a poor investment when 1) a credit bubble is bursting (although there can and will be occasional countertrend rallies to keep the bullish spirit alive) and 2) the economy is imploding (like it is now). Under the circumstances, it is not a good time to be wading in and buying stocks for the long run.

That said, I realize that some investors may still prefer to have some skin in the game, come what may. However, there's one thing that rarely, if ever, makes sense when it comes to the stock market: having all your eggs in one basket, especially when it involves the shares of the company you work for -- and your prospective retirement.

In "Don’t Paint Nest Eggs in Company Colors," the New York Times' Paul J. Lim uses the recent unraveling of Bear Stearns to drive this point home.

By helping Bear Stearns avert a potential bankruptcy, the federal government essentially declared the venerable investment bank too important to fail. Over the years, many of the firm’s employees clearly felt the same way: collectively, they accumulated one-third of the company’s stock.

Even under a revised rescue plan, in which JPMorgan Chase is offering $10 a share to buy Bear Stearns, the value of the company’s stock owned by Bear employees is now worth just a tenth what it was in December. For many of those employees, that decline is a personal catastrophe: most of their wealth is gone.

“I used to think Enron was the poster child of what not to do with company stock,” said Mike Scarborough, president of an investment advisory firm based in Annapolis, Md., referring to the energy trading company whose collapse shattered the nest eggs of employees who held so many of its shares.

“But it may ultimately turn out to be Bear Stearns, because money and investing is their business — and it still turned out badly.”

To be sure, the situations of Bear Stearns and Enron are different in many ways. For starters, just in terms of company stock, top executives at Enron encouraged workers to load up their 401(k)’s with company shares. That wasn’t the case with Bear.

Nevertheless, the rapid collapse of the investment bank’s shares — they fell to about $10 from $70 in around three weeks — offers yet another reminder of the risks associated with making concentrated bets on your employer’s stock, even if it appears to be a blue-chip investment.

Conventional wisdom says company stock isn’t that big a problem now. Thanks to the bear market and blow-ups at companies like Enron and WorldCom at the start of the decade, as well as the Pension Protection Act of 2006, retirement investors aren’t as concentrated in company stock as they once were.

In general, the numbers bear this out. In 2001, when Enron filed for bankruptcy, investors in 401(k) plans that offered company stock held 28 percent of their retirement account in employer shares, on average, according to Hewitt Associates, the employee benefit research firm. By the end of last year, that figure had dropped to 16 percent.

But many financial planners say 16 percent is still way too much to invest in a single stock, let alone that of your own employer. Think about it: $100,000 invested in the Standard & Poor’s 500-stock index would have shrunk to $90,760 since January. But had a Bear Stearns employee invested 16 percent of his money in company stock — with the remainder going into the S.& P. 500 — his account would have fallen to below $78,300. This at a time when his job may be in jeopardy.

Mr. Scarborough, whose firm advises workers on managing their 401(k)’s, recommends investing no more than 5 percent in employer stock. This is especially true for employees of a large company whose stock is widely held, because they may already own some of its stock indirectly. “A lot of diversified mutual funds in their 401(k)’s probably own those shares,” he said.

If you dig a bit deeper into the data, you’ll notice something more worrisome: Though company stock has fallen in popularity, some 401(k) participants are still making huge bets on it.

At the end of last year, nearly two of every five 401(k) participants were putting 20 percent or more of their money into employer stock, according to Hewitt. And about one-sixth of participants were investing half or more of their nest eggs in it.

This is all the more remarkable, given that many employers have been playing down company stock in worker retirement plans.

For example, among plans offering company stock as an investment, only 23 percent now use it to make matching contributions to worker accounts — or about half as many as in 2001, said Pamela M. Hess, Hewitt’s director of retirement research.

A vast majority of these plans let workers transfer instantly out of company stock. But “even though they can diversify their holdings, many participants still don’t,” Ms. Hess said.

Lori Lucas, defined-contribution practice leader at Callan Associates, an investment consulting firm, said the persistent failure of many employees to diversify their holdings was “a tough nut to crack.”

“Familiarity of company stock can be comforting to some plan participants,” Ms. Lucas said.

So far, she said, no suggested way to discourage workers from overloading on company stock has been completely successful. She added that “one approach that some plan sponsors are talking about is re-enrollment, or rebooting the whole plan.” In other words, on a given day, all workers are re-enrolled in their 401(k), as if they were new workers — but with existing balances to invest.

In a theoretical reboot, existing balances might go into a broadly diversified option like a target-date retirement fund, which invests in an age-appropriate mix of stocks and bonds and adjusts over time. A worker could then go back into company stock if desired. Or, workers would actually choose their investments upon re-enrollment.

The idea is that some workers might diversify if they were forced to invest from scratch.

Of course, most employees are free to diversify their 401(k)’s right now. The Bear Stearns experience might convince them to do so.

Comments

[Thomas Shawn]

What on earth were financial professionals thinking when they committed this fatal error. Was there a culture at Bear to load up like this. Were these folks trying to act like "big dogs" who owned the joint?

All these people deserved to lose their money and their jobs and they should leave the financial industry. Why hire someone who fails to understands the rudimentary basics of financial diversification?

[Lady From Middle America]

I agree with Thomas Shawn's statements about the Bear Stearns employees. Let's hope they seek employment outside of the financial sector.

I remember how excited I was when 401(k)'s were first introduced. They just seemed like the perfect retirement vehicle. However, 401(k)'s have been around for about 20 years now and people still seem to have a hard time understanding basic investment concepts.

I have a theory that only a certain percentage of people (my theory hasn't figured out that percentage yet - hah!) are really capable of understanding how to invest wisely in 401(k) plans. I don't think it's an intelligence issue, but more of a human nature issue. I know plenty of smart, decent, successful, loving people who will always make the wrong decision when it comes to investing. We have to figure out as a society how to treat these people when it comes time for them to retire. Do we treat them as "undeserving" and kick them out to the curb, or do we make sure there are safety nets that will catch them?