Investors are told again and again to diversify. By spreading their money over hundreds of kinds of investments, they make their portfolios safer, if less exciting.
But do you know what's going on in your own 401(k)?
Ten of the 50 largest companies in the S&P 500 still put 401(k) contributions in the company's own stock, according to Bloomberg’s ranking of retirement plans, which is based on data filed last year. That earns those companies a deduction on the ranking.
It's an “extreme example of poor diversification,” the behavioral economists Shlomo Benartzi of UCLA and Richard Thaler of the University of Chicago have written, echoing the warnings of many other economists and retirement experts. “Workers risk losing both their jobs and the bulk of their retirement savings all at once.”
The practice used to be even more common, by an order of magnitude. For decades, employees were nudged in various ways to put their 401(k) retirement plans into the company's stock. Employers used to say it boosted productivity, despite studies that undercut those claims. And they touted tax advantages that Thaler and Benartzi call “exaggerated.”
Workers, who are rarely investing experts, took cues from their employers. If employers matched 401(k) contributions with company stock, as many did, employees took that as “implicit advice,” Benartzi and Thaler say. Even offering employer stock as a voluntary 401(k) investment choice could trip up novice investors who didn't know they needed a more diverse portfolio.
The good news is that company stock is shrinking as a share of 401(k)s, so a bankruptcy or an industry downturn will hit many fewer American workers with that double whammy. Company stock holdings made up 11 percent of 401(k)s at the end of last year, data provided by Aon Hewitt show. That’s less than half their concentration in 2005 and down from more than 30 percent in the 1990s.
What changed? Enron's bankruptcy in 2001, which wiped out many employee retirements, sent up a flare. In 2006, a new federal law discouraged employer stock holdings. Companies began listening to the advice of the retirement experts, who had been urging them to stop offering company stock as a 401(k) investing option. Retirement plans started automatically steering employees into widely diversified target-date funds—workers choose the fund that matches their expected retirement year, and the fund rebalances automatically over time, adjusting the risk level. Many employers also stopped matching 401(k) contributions in company stock, putting the match in their workers' regular investment lineup instead.
Company stock and your 401(k) can be a sweet combination. Amazon.com and Celgene , for example, did much better than the S&P 500 over the past five years.
But it's a big risk. When there's trouble at your company, or an industry downturn, you don't want your retirement plan whacked at the same time your working life is destabilized.
For years, Chevron matched 401(k) contributions with company stock. Lately, that hasn’t work out well for workers, especially after last year’s plunge in oil prices. Over the past five years, the stock has lagged behind the S&P 500's returns by about 40 percentage points. This year, Chevron decided to stop matching contributions with its own shares. Spokeswoman Melissa Ritchie said the change will “help employees maintain a diversified portfolio” that meets “their goals, time horizon, and risk tolerance.”