Don't let stock in employer build up

The Baltimore Sun

On top of all the other troubles at Countrywide Financial Corp., the mortgage giant now faces a lawsuit from an employee claiming that workers lost hundreds of millions of dollars in their 401(k) retirement plans by holding the company's stock.

The California worker claims executives knew that Countrywide's risky lending practices made the stock a poor investment.

Merits of the case aside, this shows we still haven't mastered the lessons from Enron.

After that company's implosion wiped out workers' nest eggs, Congress made it easier for workers in 401(k)s to sell employer stock and diversify. Even some employers have started shooing workers away from company stock.

Surveys show investment in employer stock has fallen on average. But benefits experts say they often see individual accounts that have 70 percent or more of the money in employer stock. It's like 2001 still.

"If I said, 'I have a great idea. Put 80 percent in GE stock.' What would you say? "I'm out of my bloody mind," says Michael Scarborough, president of the Scarborough Group which manages workers' 401(k) accounts. "But they will do it if they work there."

At Countrywide, about one-third of the $1 billion of 401(k) assets at the end of last year was invested in company stock, making it the single largest holding, according to the lawsuit filed this month.

Countrywide, in a written statement, says the lawsuit has no merit. It says workers decide how to invest their money and are free to trade any vested shares they receive as a matching contribution and put the money into something else.

Too much

Many experts agree that holding one-third of your portfolio in a single stock is too much.

Last year's Pension Protection Act, for instance, requires 401(k) quarterly statements to warn workers that holding more than 20 percent of their portfolio in any one company or industry could leave them inadequately diversified.

The law went further to help workers diversify their 401(k) accounts. It requires that workers be allowed after three years on the job to sell company stock that was given to them as a matching contribution. And the Department of Labor can assess a penalty on employers for not notifying workers of this.

That penalty will be up to $100 a day for each employee who was not given 30 days' advance notice of when they're eligible to sell, under regulations that become final next month.

But even before Congress intervened, employers were taking steps to get workers to diversify, such as lifting restrictions on stock sales. Their motive isn't entirely altruistic.

Reduce exposure

"They are looking to reduce exposure to lawsuits. That's been the fundamental driver," says David Wray, president of the Profit Sharing/401(k) Council of America in Chicago. "Any time a stock has dropped 10 percent in a period of three or four months, there has been a lawsuit."

Some employers have stopped matching worker's contributions with company stock. This year, 23 percent of mid-size and large employers offered company stock as a match, compared with 36 percent two years ago, according to a survey by Hewitt Associates to be released next month.

Companies also have been capping how much employer stock you can buy, Wray says. Typically, once employer stock becomes 20 percent or 25 percent of your account balance, you can't buy more shares, he says. (You don't have to sell the stock you own, so it can still grow into a bigger share of your portfolio if the price climbs.)

Hewitt found that among employers offering their own stock in a 401(k), 22 percent of plan assets this year were invested in company shares. That's down from 26 percent two years ago.

If you look at individual accounts, though, company stock can make up 5 percent to as much as 80 percent or 90 percent of a worker's portfolio, says Pamela Hess, director of retirement research at Hewitt.

So why do some workers still risk 90 percent of their nest eggs on a single company?

Partly, it's inertia. Workers get employer stock as a match and just let it accumulate. Partly, it's comfort. Many adhere to Fidelity Investments legend Peter Lynch's buy-what-you-know philosophy and figure they know their employer best.

Misplaced trust

And partly, they're often confident - maybe too much so - that what happened at Enron can't happen to them.

"Other people's houses burn down, not mine. It goes back to the comment, 'I know my company. I know what they are doing,' Really?" Scarborough says. "Unless you own the company, you have no clue if there is fraud going on."

But it doesn't even have to be something as drastic as that. Even good companies go through slumps. And you don't want to hit a bad stretch just as you're about to retire.

You also don't want to "mistake a good company for a good stock," says Christopher Jones, chief investment officer of Financial Engines, a 401(k) adviser. The company may be solid, but the long-term growth prospects of the stock could be lackluster.

So assuming you don't have millions invested outside your retirement account and can afford to take big risks, what's the right amount of company stock in a 401(k)? None, says Scarborough. You're tying too much of your financial future to one company.

Legal limit

Some experts don't go that far, but many side with Jones' view that "generally, anything over 20 percent is pretty dangerous." Even then, those approaching that outer limit should be younger workers who have more time to recover from setbacks in the stock.

My advice: Keep employer stock at 10 percent or less. That's been the legal limit for employers who invest traditional pension money in their own stock. Adds John Hotz, deputy director of the Pension Rights Center, "If you don't know why you should have more than 10 percent, then you certainly shouldn't."

Mea culpa. In last week's column, I attempted to give a rough estimate on how much more in sales tax Maryland households would pay under the governor's tax proposal. I failed to factor in the amount that businesses pay in sales tax.

An analysis by the Department of Legislative Services found that households earning $25,000 would pay an extra $66 if the sales tax was raised to 6 percent, while those earning $125,000 and up would pay an additional $212.

To suggest a topic, contact Eileen Ambrose at 410-332-6984 or by e-mail at eileen.ambrose@baltsun.com

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