Conventional Wisdom: Company Stock

This 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.

Investing, Media | Frank Curmudgeon | November 9, 2009 12:59 pm

No Comments

By Craig, November 9, 2009 @ 2:49 pm

Very well put. The point that your present career and compensation are _already_ tied to your company’s performance is one that needs to be made over and over again. We diversify to reduce risk, and the idea that today’s bread and tomorrow’s too should all depend on the performance of one company should be terrifying to a prudent investor.

Take company stock if it’s “free,” but don’t hold on to it for one day longer than you have to.
By Paul Williams @ Provident Planning, November 9, 2009 @ 2:52 pm

Great article, Frank. You make an excellent point about the dangers of owning your company’s stock on top of working there. Why risk losing your investments along with your job if the company goes belly-up?
By SJ, November 9, 2009 @ 3:47 pm

“That could be true, but be aware of the human tendency to identify with and favor your own tribe.”
Hurrah! And that’s how we also watch and value the Dow and S&P! This argument works well for lottos too I think =)
By lucho, November 9, 2009 @ 4:58 pm

What could be said about buying stocks of the competitors of one’s company ? Lack of diversification because you have too many bets in one particular industry ?
By Kosmo @ The Casual Observer, November 9, 2009 @ 5:32 pm

Luckily, my employer is a mutual company. I can’t possible be tempted to buy up lots of company stock I definitely see how people could fall into this trap, especially if they like their job.
By Kosmo @ The Casual Observer, November 9, 2009 @ 5:33 pm

@ lucho – well, if your entire industry goes the way of the buggy whip, having a chunk of your money in that industry could be a bad idea.
By Rob Bennett, November 9, 2009 @ 7:46 pm

I agree that it’s a bad idea to invest in your employer’s stock unless the incentive provided for doing so is compelling. We all are heavily invested in our employer’s well-being by virtue of the employment relationship.

Rob
By abdpbt personal finance, November 9, 2009 @ 9:50 pm

Nice post, Frank, especially the bit about how you’ve already tied up your economic health with the company by being employed there. Too true, even if people don’t always think about it that way.
By CalLadyQED, November 10, 2009 @ 12:43 am

Great post, Frank. This makes a lot of sense for publicly traded companies.
Question: I work at a mutual holding company that sells annuities and mutual funds (among other things). One of the options for our retirement accounts is buying into one of the company’s funds which…I can’t remember what it’s called, but it’s one of those funds where the goal is to just preserve capital. Ignoring the question of how much I ought to be allocating to that kind of fund given my age, etc., does anyone think investing in my company (as I’ve put forth here) is a bad idea? I’ve got 2% in there. What do you think?
By Frank Curmudgeon, November 10, 2009 @ 10:28 am

Investing in funds managed by your employer is a different animal entirely. Especially if you are talking about a money market sort of thing, you should be fine, as the fund should do okay even if the company does poorly.
By kitty, November 11, 2009 @ 12:48 am

This is right of course, but it is an easy trap to fall into under some circumstances. Keep in mind that a lot of people who have money in their employer stock started working for this employer a long time ago – long before internet and easy access to information. Long before this crisis and even internet bubble crush. And as with any individual stock sometimes you get lucky.

I have too much of my employer stock – about 17% of investible assets or 34% of money I have in taxable accounts. Under 10% of total net worth, but I normally exclude primary residence from my calculations since I need to live somewhere.

I understand perfectly well that it’s way too much, but it just happened – historical reasons. When I started in the early 80s the company seemed rock solid with virtually no competition, long standing no layoff policy and consequently a promise of lifelong employement, so it was natural to buy for 10% of my salary and with 15% discount. Everyone told what a great investment it was. I sold a little here and there, but kept most of it. Then came the early 90s… Suddenly things didn’t go so well, it was touch and go. It was almost difficult to believe what was happening so by the time I noticed, the stock was selling close to what people said was break up price, so I didn’t sell and just continued buying. Looking back I realize it didn’t make much sense, but… it worked out for the best. The company survived though no-layoff policy was gone. The stock has done fairly well with a couple of splits since then. During internet bubble, it was really high, so a friend suggested I sell and pay off my mortgage, but I got greedy: instead of thinking of holding on to my gains, I worried about taxes and of course the price was going up and up. Of course, it dropped after the bubble as all other tech stocks, but it was still OK. But all in all, because of 15% discount and lookback feature, I still had gains overall. In 2004 I was trying to find about some stocks to sell at a loss to offset gains from the sale of rental property and couldn’t find even 100 shares of ESPP stock I could sell at a loss. Finally when the company decided to eliminate lookback provision and change the discount to 5%, I decided I had way too much of the employer stock, and that 5% wasn’t enough to offset market fluctuations. In 2007 I started to slowly reduce the exposure, sold some 300 shares, missed 2008, sold 200 shares this year and am thinking of sellling a little more. Maybe additional 200, but need to be careful to stay below AMT… as a large percentage of money there are gains.

But… right or wrong, I sure as hell happy that my money were in my employer stock rather than in an index fund during this crisis: it was $109 when I sold a bit in December 2007, $118 when I sold a month or so ago, it is $126 today. It may change, which is why I’ll probably sell some more of it soon.
By CalLadyQED, November 11, 2009 @ 5:04 pm

Re: Frank Curmudgeon, November 10, 2009 @ 10:28 am

Thanks for responding; you make a good point. Of course, if the company is doing badly because the funds we manage are doing badly…

I’ll probably keep it 1-5% of my portfolio and not worry too much.
By CalLadyQED, March 4, 2012 @ 12:22 am

It’s not just your company stock that you should avoid. You also have to diversify over industries.

I know someone who worked for NASA. When it started to look like the Space Program was closing, his retirement fund took a major hit because he was heavily invested in a private aerospace company. No job, little retirement, 50+ years old. Not fun.