Company Stock and Your Portfolio: Keep Your Eye on Concentration Risk
The opportunity to acquire company stock — inside or
outside a workplace retirement plan — can be a lucrative
employee benefit. But having too much of your retirement plan
assets or net worth concentrated in your employer's stock could
become a problem if the company or sector hits hard times
and the stock price plummets.
Buying shares of any individual stock carries risks specific to
that company or industry. A shift in market forces, regulation,
technology, competition — even mismanagement, scandals, and other
unexpected events — could damage the value of the business.
Worst case, the stock price may never recover. Adding to this
risk, employees who own shares of company stock depend on
the same company for their income and benefits.
Time for a concentration checkup?
The possibility of heavy losses from having a large portion
of portfolio holdings in one investment, asset class, or
market segment is known as concentration risk. With company
stock, this risk can build up gradually.
An employee's compensation could include stock options
or bonuses paid in company stock. Shares may be offered at a
small discount through an employee stock purchase plan, where
they are typically purchased through payroll deductions and
held in a taxable account. Company stock might also be one of
the investment options in the employer's tax-deferred 401(k)
plan, and some employers may match contributions with
company stock instead of cash.
Investors who build large positions in company stock may not
be paying attention to the concentration level in their portfolios,
or they could simply be ignoring the risk, possibly because they
are overly optimistic about their employer's future. Retirement
plan participants might choose familiar company stock over
more diversified funds because they believe they know more
about their employer than about the other investment options.
What can you do to help manage concentration risk?
Look closely at your holdings. What percentage of your
total assets does company stock represent? There are no set
guidelines, but holding more than 10% to 15% of your assets
in company stock could upend your retirement plan and your
overall financial picture if the stock suddenly declines in value.
If you work for a big company, you may also own shares
of diversified mutual funds or exchange-traded funds that
hold large positions in your employer's stock or the stock of
companies in the same industry.
Formulate a plan for diversifying your assets. This may
involve liquidating company shares systematically or possibly
right after they become vested. However, it's important to
consider the rules, restrictions, and timeframes for liquidating
company stock, as well as any possible tax consequences.
For example, special net unrealized appreciation (NUA) rules
may apply if you sell appreciated company stock in a taxable
account, but not if you sell stock inside your 401(k) account
and reinvest in other plan options, or if you roll the stock over
to an IRA. You could miss out on potential tax savings, because
future distributions would generally be taxed at higher ordinary
income tax rates.
An appropriate allocation of company stock will largely
depend on your goals, risk tolerance, and time horizon —
factors you may want to review with a financial professional.
It may also be helpful to seek an impartial assessment of
your company's potential as you weigh additional stock
purchases and make decisions about keeping or selling shares
you already own.
All investments are subject to market fluctuation, risk, and
loss of principal. When sold, investments may be worth more or
less than their original cost. Diversification is a method used to
help manage investment risk; it does not guarantee a profit or
protect against investment loss.