Owning Your Company’s Stock
Behavioral Finance | Planning Perspectives | Portfolio Management
Currently, one of the nation’s biggest banks, Wells Fargo, is in the middle of a serious scandal. The company fraudulently opened extra customer accounts without their consent or knowledge in order to boost revenue. (Click here to read story) Prior to the latest news, Wells Fargo was considered to be one of the darlings of Wall Street. Warren Buffett, a major stakeholder, loved to talk about the bank. However, since the news broke, the company’s stock price dropped, congressional hearings commenced, layoffs were announced and ultimately the bank’s CEO resigned.
The case of Wells Fargo highlights the potential pitfalls of owning too much employer stock, either from stock grants, allocating to your employer’s stock through your 401(k) or from an employee stock purchase plan (ESPP). On the surface, it’s an easy decision to allocate a portion of your investments to your company’s stock. Why wouldn’t you? You work for the company, you are part of a corporate team and it shows your commitment to your career and your employer’s growth. It makes perfect sense. However, if you maintain a high concentration of your company’s stock in your portfolio, you could be at risk. Below we highlight how being overly loyal to your employer, along with your intertwined fortunes can have a significant impact on your financial life.
Loyalty
Working for a public company, you are often encouraged to invest in your employer’s stock. If not through an ESPP, where you can get a 10% or 15% discount, then through your 401(k). When you get a discount on buying employer stock through an ESPP plan, it is compelling and often worth it. Investing in your company stock through your 401(k) does not provide you the same benefit, but it is easy. You may be investing out of loyalty and the belief that the company you work for is as good of an investment as any.
Investing in your employer can be a good thing. When your company is posting healthy, quarterly earnings and is highly regarded by many investors, why wouldn’t you be inclined to invest? It is natural. You are proud of your career, your employment path, and your company’s prospects. Why would you not take advantage of the ESPP and the ability to use your 401(k) to double-down on your company?
Truth is, no company is perfect and over concentrating your investments in employer stock can be unwise. Time and time again, big companies, profitable companies and promising companies fall out of good graces. Sometimes, its dues to lower growth forecasts for a companies in highly competitive markets. Sometimes its major, like an accounting scandal or some other fraudulent activity.
When a scandal hits, the stock drops. But that is not all. Management is left scrambling. With a drop in stock prices and a spotlight on corporate practices, everything comes under scrutiny. The company must make changes, as quickly as possible. Inevitably, these changes include new initiatives, expense cuts, and lower revenue forecasts. (Click here to see “The Ten Worst Corporate Accounting Scandals of All Time”)
As an employee, you are often left in the dark. You may think that you’ll know before others, but corporate politics dictate only those who need to know will know. Even if you did know before the public, you could be guilty of insider-trading if you trade on the information. It is difficult to predict a downturn in your employer’s fortune. If the stock takes a hit, you will be affected and you won’t be able to avoid it. Blind loyalty to a company can lead to nasty surprises and ultimately result in a big hit to your portfolio, unnecessarily.
Intertwined Fortunes
When bad news breaks, it is usually followed by more bad news. In this case, the news is usually in the form of layoffs. An employer’s biggest expense is often their employees. Costs of salaries, benefits, unemployment taxes, insurance and office space to meet the needs of their work force come under scrutiny.
While the company’s stock price is falling, the risk your job is under a microscope is now a real possibility. If the bulk of your 401(k) or overall portfolio is invested in the stock, you will suffer from a drop in your portfolio value. Now, you may also lose your job and your income. The two events are intertwined and effectively become a double-whammy to your personal financial situation.
Losing your job and suffering a significant loss in your investments at the same time is a plausible scenario when bad news befalls a public company and you own a significant number of shares. If you’ve avoided over concentrating your investments in your employer’s stock, then the effect on your personal situation is minimized. Being pragmatic about your employer’s future and how it could affect your personal situation, is key. Don’t invest with blind-faith and remember the real exposure you have from the intertwined fortunes.
You hear this often: diversification can preserve wealth and concentration can create wealth. Not everyone is lucky enough to work for companies that have experienced exciting growth over the years (MSFT, AAPL, AMZN, GOOG, etc.) If you do work for these companies, you may know people who have benefited greatly or on the flip side have been the victims of poor timing when it comes to making or losing money in their company stock. Despite the growth, all companies experience wild rides.
There is a strong case to be made for having an equity stake in your employer. In the case of executives, its imperative management shows their commitment to the company through stock ownership. It does indeed help align managements interests with those of their shareholders. However, for most employees being aware of your exposure and the pitfalls can ensure you are ready when the unexpected happens.