business

Nest Eggs Need Diversity

The damage Enron's debacle has inflicted on its workers' 401(k) plans can't be repeated elsewhere -- and Congress can make sure it doesn't

By Christopher Farrell

The poet Robert Browning wrote:

"Grow old with me!

The best is yet to be,

The last of life, for which the first was made."

Imagine how bitter those words must sound to Enron employees. Not only have some 4,000 workers lost their jobs, but many more have seen their retirement savings decimated by the energy company's collapse. Enron's employees -- with encouragement from the company -- had invested a big chunk of their tax-deferred retirement savings in the stock, which topped out at around $85 about a year ago but is now worth pennies a share.

Worse yet, the company's pension plan blocked employees from unloading Enron stock even as it tumbled toward the largest Chapter 11 filing in U.S. history (). Talk about being chained to the deck of the Titanic.

Too many workers are at risk of suffering a similar fate with their retirement savings. Equities accounted for three-quarters of plan balances for the nearly 12 million 401(k) participants in the Employee Benefits Research Institute/Investment Company Institute database. Of that equity exposure, 19% was invested in company stock. Some employers pay their matching contributions in company stock. In those plans, corporate equity represents a full 33% of the retirement savings balance.

MARGIN OF SAFETY.

  So the question is: Why should workers have to put any of their 401(k) tax-deferred retirement savings into company stock? Employees' income is already at risk if company profits decline. In many communities, their home values are vulnerable to corporate collapses.

Besides, diversification -- the notion that savvy investors never put all their eggs in one basket -- is among the most celebrated concepts in modern finance. Spreading long-term savings among different assets, such as stocks, bonds, real estate, and cash, cushions the volatility of a portfolio and buys the owner a margin of safety during troubled times.

There's a better way to give employees a vested interest in the growth of their company. Stock options are a more effective mechanism than retirement-savings plans for tying employees closer to a company's market performance. Similarly, options are preferable for employees eager to gamble that their company is a high-flying stock.

PORTABLE PLAN.

  Employees should always be extremely careful when allocating the assets in their 401(k) portfolios. But Congress should consider barring employers from encouraging employees to load up on company stock in a retirement plan. Now, a call for new laws is always risky in the pension arena because of an ongoing tension between regulatory restrictions and pension-plan freedom. However, it's clear that too many employers make it difficult for their workers to follow modern portfolio theory -- a towering intellectual achievement of the past century.

The Enron debacle should also force Congress to revisit the basics of the entire defined-contribution pension-plan system. The democratization of the financial markets through the 401(k), the 403(b), the 457, the IRA, and other defined-contribution plans is here to stay. These plans are well suited to a highly mobile job market marked by millions and millions of layoffs and hirings every year.

It's the individual worker, not the employer, who shoulders all the investment risk. That's why the pension plan should be attached to the individual and not the employer. Anyone who embarks on a career should automatically get a 401(k) plan offering a diverse menu of mutual-fund options. The tax-deferred plan moves with the person. Then, pension plans would be completely portable and genuinely diversified.

The Biggest Bankruptcies

1980 to Present

Company Date

Total Assets

Before Bankruptcy

(billions of dollars)

Enron 12/2/01 $63.4
Texaco 4/12/87 35.9
Financial Corp. of America 9/9/88 33.9
Pacific Gas & Electric 4/6/01 21.5
Mcorp 3/31/89 20.2
First Executive 5/13/91 15.2
Gibralter Financial 2/8/90 15.0
FINOVA Group 3/7/01 14.0
HomeFed 10/22/92 13.9
Southeast Banking 9/20/91 13.4
Reliance Group Holdings 6/12/01 12.6
Imperial Corp of America 2/28/90 12.3
Federal-Mogul 10/1/01 10.2
First City Bancorp of Texas 10/31/92 9.9
First Capital Holdings 5/30/91 9.7
Baldwin-United 9/26/83 9.9
Data: BankruptcyData.com, New Generation Research Inc.

Farrell is contributing economics editor for BusinessWeek. His Sound Money radio commentaries are broadcast over National Public Radio on Saturdays in nearly 200 markets nationwide. Follow his weekly Sound Money column, only on BW Online

Edited by Douglas Harbrecht

    Before it's here, it's on the Bloomberg Terminal. LEARN MORE