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Got a Big 401(k)? Chances Are, You Got a Problem

Think the wealthy have a leg up on financial smarts? Think again. Retirement advisory firm Financial Engines recently took a spin through nearly 3 million 401(k) accounts and found that among folks with at least $500,000 in assets, about one-third had in excess of 20 percent of their retirement account invested in their company stock. Yikes.

A very basic rule of diversification is to keep any single stock investment to no more than 10 percent of your assets. So put another way, about one-third of the folks with bulging 401(k) accounts are taking twice as much risk with their retirement account as is deemed prudent. Sure, if they have boatloads more retirement money in other accounts maybe the overall impact of their company stock is mitigated. But I’m not betting that is what’s going on. The fact is, we get lulled into thinking the company we work for could, never, ever disappoint. And that’s just asking for trouble.

To be fair, it’s not just the well off who are screwing this up. According to the non-partisan Employee Benefit Research Institute, more than one-third of folks with access to company stock within their 401(k) have more than 10 percent of their assets riding on their company’s stock.

Who Has More Than 20 Percent of Retirement Assets Riding on Company Stock?

asset allocation

Source: EBI

Among the 50-something crowd, about 40 percent have in excess of 10 percent tied to the fortunes of their employer’s stock. And as the table below from EBRI shows, among those Baby Boomers 13.5 percent have more than half of their 401(k) riding on company stock. Double yikes.

Maybe you have a pretty good line on the fact that your firm isn’t committing outright fraud, so you’re not too worried about Enron risk: At the time Enron went under, the majority of employee retirement assets were invested in company stock. Granted, the fraud issue is a bit of an outlier. But you can’t know for sure what external factors might smack your company stock. For example, BP’s stock plunged about 50 percent in the wake of the 2010 Gulf Oil spill. That smacked BP workers silly: turns out that about one-third of the firm’s 401(k) was sitting in company stock.

The point is you just can never be absolutely sure. One of the biggest favors you can do your 401(k) and retirement security is to apply Pascal’s Wager to your decision-making process. Full disclosure, Pascal was in fact a 17-century mathematician and philosopher. But his advice could not be more spot-on for today’s 21-century investing world. Pascal laid down an elegantly simply challenge to our thought process and decision-making. Here’s a pared down paraphrase of Pascal’s challenge:

When you can’t be sure of something, what is the consequence of your assumption being wrong?

So, um, what’s this got to do with your 401(k)? Well, let’s say you have a big chunk of your retirement account riding on your company stock and it turns out you were “wrong” in the sense that something — anything — triggers a big drop in the stock. The repercussion is going to be a lot more severe than if you were “wrong” and had just 10 percent or less of your 401(k) invested in the stock. (For more on Pascal, check out Against The Gods –The Remarkable Story of Risk by Peter Bernstein. You can also get a taste of Bernstein’s spin through Pascal and other masters of probability in this paper.)

Come on, you can’t honestly argue with the logic of mitigating your risk. So if you have more than 10 percent or so of your retirement assets riding on company stock, time to think about diversifying a bit. Even if your employer gives you your matching contribution in stock, you can swap it for any of the other investment options inside your 401(k). That’s not betting against your employer. It’s safeguarding your future. Your career is already tied to this employer, perhaps you also have stock options that tie you to the fortunes of the company’s stock. That’s great. But because of all that company-specific risk in your career, it becomes even more important to vigilantly keep your 401(k) from making too big a wager on company stock.

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