Conventional Wisdom: Company Stock

B&O_stockThis is the fourth in a series inspired by a toy at CNNMoney. Previous installments covered housing payments, emergency funds, and asset allocation.

Today’s topic really ought to be a lay-up. The tool asks "How much of your portfolio is invested  in your employer’s stock?" Obviously a trick question. The correct answer is so clearly zero, barring special circumstances or incentives.

Alas, no.

In a bear market, it’s tough to find a safe haven – a lot of the stocks in your portfolio will be sinking too. But don’t compound the risk by holding too much in any one stock. Best to keep it below 10%.

This bit of psuedo-wisdom assumes and implies so much that is wrong that I hardly know where to begin.

Should a person be investing in individual stocks at all? My position is that on a strict dollars and cents basis the answer is no. For non-professionals, picking stocks is at best an enjoyable and cost-effective hobby, but like all hobbies it is one that will in the long run cost money.

If you did invest in individual stocks, should you ever have 10% of your portfolio in one stock? Keep in mind that this is percentage of the whole investment kitty, not just the part in stocks. And when CNNMoney says "below 10%" they don’t mean far below. Type 10% into the tool and you get the message "Good work. You’re steering clear of your employer’s stock."

As previously discussed, this tool recommends 120 less your age as an allocation to stocks, so a 70 year old with half his wealth split evenly between five stocks would get the thumbs up here. As dismissive as I am about mainstream advice, even I can’t imagine that this really sounds like a good idea to very many people.

Professional investors are fond of saying that diversification is the only free lunch there is. In other words, lowering your risk by spreading out your bets is one of the few really cheap ways to make yourself better off. Having more  than a few percent of your savings in a single name is risky, almost certainly pointlessly so.

Ah, but isn’t your employer’s stock a special case, you ask. Yes, but possibly not in the way you think. The fate of the company for which you work will have an impact on your economic well being via your career, never mind stock. If it does well, you will have more opportunity for advancement and/or may get paid more. If it sputters, you may find yourself in a dead-end job with a pay freeze, or worse.

Owning the stock of your employer on top of the economic risk you already take by working there is pouring gasoline on a fire.

The complication to this simple rule, what I alluded to above as special circumstances and incentives, is that companies often go to lengths to induce employees to own their stock. In principle, this is in order to align the employees’ interests with those of company ownership. The fact that paying employees in stock and/or stock options is relatively cheap to do may also explain some of its popularity.

You may think that your company’s stock is a particularly good investment. You may even have convinced yourself that this is because Wall Street doesn’t understand the business as well as you do. That could be true, but be aware of the human tendency to identify with and favor your own tribe. If you are a sports fan, consider how optimistic you tend to be at the start of the season and how more often you are disappointed by the final outcome than pleasantly surprised. Chances are you are using the same clouded judgment when you decide your company’s stock is a buy. Better to find some other investments in which you have less emotional baggage.

It’s hard to give generic advice on what to do about employee stock schemes because there is such a great variety of them out there. But the basic principle should be clear. Avoid your employer’s stock. If you get stock options or can buy stock at a discount, cash it out as soon as you can. The ideal level of employer stock ownership is zero.

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