Overinvesting in company stock

October 8, 2008

Yesterday's testimony on the effects of recent financial market turmoil on pension assets has generated a significant amount of interest, so I wanted to follow up on one topic: overinvestment in an employer's stock.

Many participants in retirement plans appear to be taking on unnecessary risk by investing in individual stocks rather than a diversified portfolio. The result is that those workers assume excessive risk for which they do not receive a higher expected return. (Those workers may feel they have inside information or insights that will allow them to outperform the market with particular investment choices, but the evidence suggests that unless you're Warren Buffett, trying to outguess the market usually doesn't work.) Investing excessively in one stock that also happens to be your employer's stock is even riskier -- if the company runs into trouble, both your retirement assets and your job may be in danger.

Despite those risks (again, for which workers don't receive higher expected returns on their investments, on average), a significant number of 401(k) participants hold the bulk of their assets in company stock. According to calculations by the Employee Benefits Research Institute, 47 percent of 401(k) participants were enrolled in plans that offered company stock as an option as of the end of 2006. Of those participants, 7.3 percent heldmore than90 percent of their assets in company stock, and over 15 percent held over half their assets in company stock. (See page 33 of EBRI Issue Brief 308, 401(k) Asset Allocation, Account Balances, and Loan Activity in 2006.) At yesterday's hearing, I didn't make clear that the 7.3 percent figure applied only to those who were in plans offering company stock. So the overall share of 401(k) participants with 90 percent or more of their assets invested in company stock is more like .47*7.3=3.4 percent. It's still too high.

The good news is that the trend is towards less investment in company stock. For example, in 1999 EBRI estimated that 19.1 percent of all 401(k) assets were held in company stock. (See figure 20 on page 26 of EBRI issue brief 308.) By 2006, that share had fallen to 11.1 percent, undoubtedly driven in part by the example of the collapse of Enron and other corporate failures. In addition, provisions of the Pension Protection Act of 2006 limit the amount of time that an employer may insist participants keep assets in company stock.

Despite these auspicious trends, there remains substantial scope to improve the balance of risk and return for participants in defined-contribution pension plans, including through increased use of low-cost diversified index funds.