Employers sometimes match employee’s 401(k) contributions by using company stock. Once the stock is deposited to the account the employee can sell it (although they may be restricted to holding it for a certain amount of time first.) Employees also amass company stock through ESPP, or Employee Stock Purchase Plans, in which the stock is offered to the employee at a discount. I often find that employees hold on to company stock, letting it build up to become a large portion of the account. This is dangerous for a couple of reasons.
When a client comes to me in this situation he (or she) usually tells me that they “know the company” and are very confident in the stock. But how well do you really know the company? Unless you’re in a top management position you don’t know what decisions are being made that could affect the bottom line. And if you did know, the stock you would be given would come with a lot more restrictions on your ability to sell it. In addition, any company can succumb to poor or fraudulent management. Remember Enron anyone?
Another reason to diversify is that your income is dependent on that company. Why should your investments be dependent on the same risk? Why open yourself up to the risk of losing your income as well as some percentage of your portfolio, both for the same reason?
Finally your company may well be financially strong, with good long-term prospects. But forces beyond their control – like the market downturn we have just experienced – could reduce its value. I often think of a prospective client who walked into my office in 2007 with a $1 million 401(k), all in GE stock. He “knew the company” and wasn’t going to diversify until the stock hit $40 (it was around $36 at the time.) Needless to say he didn’t hire me because my advice was to diversify. I thought of him over the next few years as I watched GE hit $40 briefly – and then sink to about $5 during the recent recession. I certainly hope he sold when he said he would.
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