Employee stock plans. Bonuses with options. It is easy for some employees to amass big holdings of their employer's stock. But keeping a big chunk of your portfolio in a single stock is risky: If the company hits a rough patch, your investments will, too.
Marlene Roth, a longtime employee of MCI and Worldcom, found that out the hard way. She said she had nearly all of her non-401(k) investments in company stock and options, which became worthless after Worldcom filed for bankruptcy. In total, she estimates she lost around $800,000. "Once the bankruptcy came out — that's when it became clear that, yeah, it's all gone," she said. "All the savings were gone."
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Roth's circumstances may be unusual — Worldcom's 2002 bankruptcy filing was, at the time, the largest bankruptcy filing in U.S. history and came after the company revealed it had improperly booked more than $3.8 billion in expenses — but investing in an employer's stock is not. According to a study by Towers Watson of the holdings in 100 very large employers' 401(k) plans, 75 percent maintained company stock among the assets. Within that group, about 40 percent of the plans had 20 percent of more of their assets in the stock.
Owning company shares is not a danger in itself, as long as employees have diversified their holdings. In fact, some employers see benefits in encouraging workers to invest in the company's stock. There's a belief that "if employees feel connected, they will have higher productivity in the workplace," said Marina Edwards, a senior consultant at Towers Watson.
Company stock has become somewhat less common overall in retirement plans; Fidelity Investments researchers found that within defined contribution plans, allocations to company stock averaged 14.6 percent as of June 30, down from nearly 20 percent in June 2007. But it persists at a number of large employers. According to research by Pensions & Investments newspaper, large companies including ExxonMobil, Chevron, and ConocoPhillips, had allocations to company stock in their investment menus in 2013 above 42 percent, higher than 2007 levels.
Diversification does not just apply to stocks. Investors with exposure to multiple asset classes have greater protection against market downturns, in addition to the vagaries of any individual stock.
T. Rowe Price analyzed the performance of stocks, bonds and cash from Dec. 31, 1984, to Dec. 31, 2014, and found that an all-stock portfolio would have outperformed any other mix of assets, generating an average annual real return of 8.6 percent — but at a price. The average loss in the down years was 16.6 percent, and the worst year saw a negative return of 37 percent. Anyone who had to cash out in those years would have paid a hefty price.
In contrast, a portfolio made up of 60 percent stocks, 30 percent bonds, and 10 percent cash would have generated an average annual real return of 7 percent. But the average decline in any of those years was negative 6.7 percent, less than half that of the all-stock portfolio, and the return for the worst year was minus 18.1 percent. Put another way, this more balanced portfolio delivered 81 percent of the returns of the all stock portfolio with less than half the risk.
Another reason to diversify is that the top-performing asset class can change from year to year, so exposure to a lot of them increases the chances that you can lift your portfolio. MFS, the investment management firm, has analyzed the top-performing asset classes over 20 years, and found that the top-performing asset class only repeated once, in 1998 and 1999.
"Everyone wants to be in the best-performing asset class every year," the researchers wrote. "The thing is, few people are savvy enough to consistently choose the best."
Consider, for example, the fact that the winning asset class in 1998 and 1999 was large-capitalization growth stocks — and in 2000, their annual return was a painful minus 22.42 percent, at the bottom of the MFS heap.
Edwards said she worries most about people nearing retirement who have not diversified their holdings —or worse, are heavily invested just in their company's stock.
"I would say that in every plan that doesn't have a limit" on how much company stock an individual can own, "there are pockets of people that are 100 percent in company stock," she said, anywhere from 0.5 percent to 3 or 4 percent of the plan participants. "That's somebody's grandmother or grandfather that, with a swift turn of the economy or something goes wrong, they no longer have enough money to retire."
Roth, for one, is escaping that fate, though not without major damage to her investments. She has now diversified her portfolio almost exactly the way her financial advisor Geri Pell of Pell Wealth Partners has recommended, she said. She is also dabbling in foreign exchange trading. But for anyone considering the same, she warned, "don't go off the deep end."
Her takeaway from the whole experience? "Diversify. That's key," she said. "I strongly advise anybody to do that."