Company Stock in 401(k) Plan May Expose You to Big Losses

401(k) plan investors who’ve plowed all or most of their retirement savings into stock mutual funds may have lost money this year, but they aren’t the biggest losers in the recent market slide.

When quarterly statements are mailed out after the end of this month, the real losers are likely to be plan participants who’ve invested heavily in their company’s stock.

“It’s going to be a shock to them,” said Christine Fahlund, a financial planner with T. Rowe Price Associates in Baltimore.

And that should serve as a wake-up call to investors about the merits of diversification--and the dangers of concentrating assets in a single stock, planners say.

Consider the numbers: By last week, 80% of all common stocks listed on the New York Stock Exchange and more than 95% of Nasdaq shares had plunged 20% or more from their 52-week high prices, according to Merrill Lynch.

Investors in smaller stocks have been hit hardest. The smallest stocks--companies with market capitalizations (stock price times the number of shares outstanding) of $250 million or less--are down, on average, a stunning 54% from their 52-week highs, according to Salomon Smith Barney.

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Imagine you work for Boeing, Southern California’s largest private employer, and you started the year with $100,000 in company stock in your tax-deferred 401(k) retirement plan. Today, that asset would be worth less than $72,000.

That same $100,000 invested in shares of Irvine-based Western Digital at the beginning of the year would be worth just $64,000 today. And Northrop Grumman employees would be even worse off--they’d be left with only $52,000.

By comparison, 401(k) investors who began the year with $100,000 in the typical diversified U.S. stock mutual fund would still have about $92,000, according to fund tracker Morningstar Inc.

For many 401(k) investors, the problem isn’t how poorly individual company stocks have fared, but rather how much of their 401(k) money is allocated to that asset.

The Spectrem Group, a Connecticut-based research firm, reports that company stock was the second-most-popular 401(k) investment option last year, accounting for 21% of all 401(k) assets.

In some plans, company stock is even more popular. According to recent figures from the Institute of Management and Administration in New York, a research firm, three-quarters of Coca-Cola’s 401(k) plan assets were invested in Coke stock. At drug maker Pfizer, the proportion is even higher: 82%.

Though investing in Coke or Pfizer has proved to be a winning formula in recent years, the stocks are down 26% and 11%, respectively, since the stock market peaked on July 17.

And for every employee at Dell Computer who covets that highflying firm’s stock, there are employees at former high fliers such as Digital Equipment who can tell horror stories about their stocks’ collapse, planners say.

Yet 401(k) investors appear to be pouring more--not less--money into company stock via their 401(k)s as of late, even as the stock market has plunged.

Employee-benefits consulting firm Hewitt Associates of Lincolnshire, Neb., for instance, reports that on Aug. 27, when the Dow Jones industrial average plunged 357 points, more than 60% of the 401(k) money that was moved out of stock mutual funds that day was shifted not into safer choices such as bond funds or money market funds, but into company stock.

On Sept. 4, as the market continued its slide, 401(k) investors pulled money out of nearly every stock fund category. Yet more than half of the money shifted that day went into company stock.

“There’s a logic to this, but a faulty one,” said Raymond Russolillo, director of personal financial services for PricewaterhouseCoopers in New York. “The employee may be thinking, ‘I’m afraid of what’s going on right now, [but] I know I should be in the market and I think my company is doing well.’ ”

In that sense, 401(k) investors may be relying on a style of investing popularized by Peter Lynch, the famed former manager of the Fidelity Magellan fund. His school of investing says you should invest in companies you’re most familiar with.

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Unfortunately, many 401(k) investors think they know more about their companies’ prospects than they actually do, experts say.

Russolillo notes that just because you’re aware that your company is handing out raises or adding to its staff doesn’t mean it’s in good financial shape. Nor is either of those things a sign that the company’s share price is bound to rise--or avoid a steep plunge.

The bottom line: “Having 90% or 100% of your [401(k)] money in company stock, which some people do, is extremely risky,” said Ted Benna, head of the 401(k) Assn., a consumer group based in Cross Fork, Pa. “It’s extremely foolish, especially if you’re at or approaching retirement. It goes against all the rules of diversification.”

Even in a raging bull market, when the majority of stocks are rising, financial planners warn against having too much 401(k) money in company stock.

Notes Dee Lee, president of Harvard Financial Educators of Harvard, Mass., and coauthor of the book “The Complete Idiot’s Guide to 401(k) Plans”: “If you invest too heavily in company stock, you’re tying everything--your pension, your job and now your 401(k) plan--in that one company.”

If your company runs into financial troubles, employees could find themselves being laid off at the same time their retirement savings are shrinking.

Because of the risk, Ron Roge, a financial planner in Bohemia, N.Y., advises his clients to invest no more than 10% of their 401(k) accounts in company stock. Other planners allow for a higher number, but never more than 25% of assets.

But keeping to that maximum can be difficult for many workers.

Why? Although large employers tend to match employee 401(k) contributions--in other words, if the employee invests $1,000 in his or her account, the company puts in some percentage or fully matches that amount--many match in the form of company stock, Benna noted.

That’s the case with Rockwell International Corp., for instance, and also with Pfizer and Coca-Cola.

In fact, according to the benefits consulting firm Buck Consultants, based in New York, more than 20% of companies match employee 401(k) contributions with company stock, or a combination of cash and company stock.

And 83% of those that do match in company stock also prevent or limit employees from moving out of that company stock into other investment options within the plans.

If you have no choice but to take company stock as a matching contribution, financial planners generally advise that you avoid exacerbating the problem: Direct your own contributions into diversified stock funds or other assets rather than company stock.

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Paul J. Lim can be reached by e-mail at paul.lim@latimes.com.

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Betting on the Company

More than one-fifth of individuals’ 401(k)retirement plan assets were in their own companies’ stock last year, making it the second-heaviest allocation among asset choices.

Diversified equities: 33%

Company stock: 21%

Stable-value*: 18%

Balanced: 11%

Bonds: 7%

Other: 10%

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Stable-value investments promise a set rate of return (or range of rates) for your money.

Source: Spectrem Group