Don’t Buy Company Stock in 401(k)

Bear Stearns had 85 years of straight profits before last week’s spectacular implosion, when they were sold for $2 a share to JP Morgan Chase (and essentially the Fed). While the price was increased to $10 a share this week, the bottom line is that a lot of shareholders lost a lot of money and it’s estimated that 30% of the company was owned by insiders such as employees. In the case of Bear Stearns, bonuses were paid in shares, but this is a situation that could happen to anyone in any firm.

At my first employer, we had the option of buying a “mutual fund” that comprised entirely of Northrop Grumman company stock. The fund did very well in the years I was there because of extensive defense spending and did well in years afterwards (again, because of extensive defense spending). Some people, in seeing those returns, may have been tempted to put more money in such a high performing equity fund but it would’ve been a mistake on multiple levels.

Ultimately, the problem is with diversification. Most people only consider diversification from an asset perspective. Do I have a good mix of equities and bonds, domestic and international, or small and big capitalization. Some people consider tax diversification, such as tax-deferred assets, tax-free assets, and taxable assets. Very few people consider how their assets related to their primary income stream, their job.

If I’m in the financial sector, perhaps I shouldn’t invest in companies in financial sector because a downturn in the market hits me in two places. If I work for Citigroup, I don’t want to invest in JP Morgan, Lehman Brothers, etc. because if the market goes south then not only do I risk losing my job (or taking a paycut, not getting a raise, etc.) but my investments fall as well. This is more acute when talking about the purchase of company stock. If I lose my job because the company goes under, there’s nothing I could’ve done… but if my retirement assets are pegged to the performance of my firm, I’m doubly screwed.

The lesson here is that the compendium of investments is very large and you should not invest in your employer, you have enough riding on it.