(MoneyWatch) Another day, another day of losses for Facebook's (FB) stock. The stock is now down over 25 percent from its IPO price, an event which occurred less than two weeks ago. As the sell-off continues, there is only one silver lining: At least employees haven't loaded up on the stock inside their 401 (k) plans...yet.
It's time to talk about why investing in your company stock inside of your 401(k) plan can be dangerous. The Facebook example would be painful, but there is another name that might jog your memory about the topic: Enron. When the energy firm went bust in 2001, over 60 percent of its 401(k) plan was invested in Enron's stock. The high percentage was partially due to employee confidence in the company and partially due to the company's internal rules that prohibited employees from selling their positions in company stock. As a result, Enron's bankruptcy not only vaporized jobs, it also wiped out retirement savings for thousands of employees.
Even before Enron made headlines, I recall warning clients against investing too much of their retirement accounts in company stock. But in many cases, the dot.com bubble was too strong a force. People would say, "My company stock is up way more than the market, so I'm fine with the risk." I would counter that if something went wrong in the company, not only would the clients' jobs be at risk, so too would their retirement savings. My advice was to limit exposure to company stock to 5 to 10 percent of the overall account balance.
After the dot.com bubble burst, financial advisers hoped for substantive pension and 401(k) reform in the Pension Protection Act of 2006 (PPA). The law mandates that employees be able to sell company stock at any time, which was a vast improvement over the previous rules allowing companies to dictate when employees could sell company stock. The law also requires plan sponsors to provide education about the importance of diversification, which is always a positive. However, when it comes to shares that a company grants through retirement plan matches, the change was minimal: Employees still can be forced to hold on to these shares for as long as three years, a virtual eternity for investors.
In the end, the law fell far short of what is needed to protect retirement plan participants. In my view, the government would better serve future retirees by banning the inclusion of company stock inside 401(k) plans entirely. Unfortunately, there's a financial incentive for companies to fight that change: Employees represent a large pool of would-be investors and tend to be among the most loyal of stockholders, sitting on big positions due to inertia and faith.
Short of a ban, it would make sense to prohibit companies from matching 401(k) contributions with their stock and to limit the amount of money that participants can maintain in the company stock, perhaps to a maximum of 20 percent. The good news is that corporate America is ahead of lawmakers on the issue. According to benefits consulting firm Aon Hewitt, only 12 percent of companies provide a company stock match, down from 45 percent in 2001. And only 1.2 percent of plans that provide a stock match bar employees from selling that stock immediately.
If you purchase company stock in your 401(k), or your company matches in the stock, the best way to manage the risk is to select automatic rebalancing every six months. By doing so, you will ensure that you sell the stock and diversify your account with other investment choices. If you don't know how to diversify, take a risk assessment test with your plan provider, which should guide you. If your plan doesn't offer automatic rebalancing, make a note to rebalance the account every six months. While it is a chore, remember: The stock that looks good now, can harm you later.
Nobody wants to get Enroned...or Facebooked...
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