Retirees and Pre-Retirees: Lighten Up on Company Stock

Telling people to lighten up on the stock of their employer is a little like advising them not to gorge on junky food. Although they fully understand the pitfalls of doing so, many keep right on doing what they're doing.

Just as Reese's Peanut Butter Cups and McDonald's fries beckon because they're tasty, it's easy to see why many people feel compelled to load up on company stock. For starters, employees might (might!) have a valuable information edge over outside parties when it comes to assessing a company's performance trajectory. Some companies also offer the opportunity to buy company stock at a discount, providing an additional incentive for employees to give their own stakes a boost. Finally, there's an emotional component. If you've worked at a place for a long time, you might have naturally become a believer in your company's products and services, not to mention its people.

Those reasons (especially the first two) all have some legitimacy, so it's a mistake to make the blanket statement that employees should never hold shares of their own companies. There's also empirical proof to consider: When you think about how most truly wealthy people made their fortunes, it often comes back to having had a sizable ownership stake in a company they helped build.

At the same time, investors go overboard with company-stock holdings at their own peril. The reason is pretty straightforward. If your financial livelihood (that is, your paycheck) is riding on a single company, staking a big chunk of your savings with that same firm is the equivalent of doubling down on a bet. From the onetime Enron millionaires to the Lehman Brothers employees we saw packing up their desks en masse, every financial crisis seems to bring shocking stories of employees who gambled heavily on their firms' shares only to lose close to everything in the end.

And the perils of holding too much in company stock don't end once you stop working. I recently spoke to a group of retirees, many of whom had spent much of their careers at a single firm and had sizable stock holdings in it. Their stock had done well, but my advice to them was exactly the same as it would be if they were employed: Be careful, my friends, be very, very careful.

What Else Is Riding On It?
First of all, even though retirees may no longer be receiving a paycheck, they might still have a financial connection to their former employer via a pension or health-care coverage. That means that financial turmoil at the firm could spell double trouble for retired stockholders, causing a drop in the value of their holdings as well as a possible disruption in income or health-care coverage.

Of course, a share-price decline doesn't automatically translate into a broad-scale financial calamity that would force a firm to cut back on retiree benefits. And in a worst-case scenario, most pensions are backed by the Pension Benefit Guaranty Corporation. (This article discusses how to check up on the health of a pension as well as some strategies to employ if it looks like yours pension is in trouble.) Nonetheless, it's safe to say that the more financial goodies your employer is providing you in retirement, the more you'd want to diversify away from its shares in your portfolio.

How Diversified Is Your Equity Portfolio?
Retirees who are receiving benefits from their former employers aren't the only ones who should be careful with company stock. The big reason is that as you get closer to retirement, you not only want to scale back the size of your equity position, but you also want to be sure that your stock portfolio is as diversified as it can possibly be. A big performance decline in one or two of your major holdings during retirement wouldn't just be emotionally taxing; it could also have tangible ramifications, requiring you to scale back on your standard of living or reducing the amount that you were hoping to leave to your children and grandchildren.

Whether you're holding the stock of your former employer or some other firm, capping individual position sizes at 5% or 10% of your equity portfolio will help limit the pain any one firm can inflict on your nest egg. Also stay attuned to whether your equity portfolio has sizable sector bets, as many people are inclined to load up on shares not just of their employers, but also on other companies in that same industry.

How Sharp Is Your Information Edge?
As I noted earlier, employees often hold their company stock because they feel they know the firm well and are good judges of its prospects. This information edge may be illusory even for folks who are still employed, but it's certain to dull considerably once you're retired and no longer involved in the firm's day-to-day workings. Even if you knew your firm's products and management cold when you were employed there, your former company--and the marketplace it operates in--can change dramatically in the space of just a few years.

Are Your Emotions in the Mix?
Last but not least, retirees who own a lot of company stock may be commingling their fondness for the firm where they built their careers with the investment case for owning its shares, and one doesn't naturally follow from the other. In a related vein--and this is true not just for retirees who are company stockholders--we humans have a natural inclination to get the most comfortable with an investment after it has exhibited very strong recent performance. At that point, its valuation might be looking rich, and it might also be taking up an outsized share of your portfolio. To help guard against making such a behavioral mistake, check with outside sources for an unbiased view of your firm's valuation. Also make sure that you're periodically rebalancing your portfolio, not only to restore your portfolio's asset-allocation mix to your targets, but also to scale back on your position sizes in individual names.

 

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