Even though I generally try and avoid investing in individual stocks due to the uncompensated risk and my inability to pick winners, I know there are still millions of people who do it every day. And of those millions of investors, I bet a lot of them have their money invested in their employer’s stock.
Even though we’ve seen stories in the past of horrible things happening to employees with a lot of company stock (think Enron), employees still invest in their company for a variety of reasons. Sometimes compensation is handed out in employee stock at a startup, bonuses are given as company stock, or your 401(k) investments might even default to company stock, like what happened with my last employer.
I don’t know why other people invest in company stock, but I know many of them do it. In fact, I’m actually one of those people, since my former employer auto-invested the company’s contribution to my 401(k) into company stock.
Here’s how it worked. Employees would receive a company contribution of 3 to 5%, depending on age, and up to another 4% matching contribution. My grand total for the company’s contribution was 7% since I’m so young but 3% of that went straight into company stock.
I like keeping my accounts as simple as possible, which is why I usually recommend a total market fund (VTI), a total international fund (VT) and a total bond fund (BND). Since I was paid every two weeks, it seemed like a lot of hassle to go in every two weeks and move over a small amount into one of these three funds. Instead, I decided to wait until I accumulated three months’ worth of contributions and then I’d go in and make the transfer.
Unfortunately, this plan was a lot harder to put into action than I thought it would be since the amounts were so minuscule compared to my overall portfolio. After about a year of contributions, I think I’d made only one transfer. Companies employ auto-investment strategies like this because they know that most people aren’t going to take the time to transfer the money over. In my case, their plan worked but why exactly do companies want their employees invested in company stock?
The answer is pretty simple actually. Imagine you started a business with a friend. You would both probably be extremely motivated to work hard and succeed since you’d see a direct correlation with the success of your company and the worth/income you were bringing in.
Large employers try to employ this same empathy factor but on a smaller scale. They know that employees who feel invested in the company are going to be willing to work harder, work longer hours, and give it their all so that the company will succeed and in turn their stock price will go up.
In theory this sounds great, but it doesn’t always work like that. Once you get into a more macroscale with thousands of employees, it takes a majority of them acting like this in order to boost the company’s profits. One of the things I hated at my last job was how little my work mattered. I was just one of thousands and I didn’t feel any correlation between the amount of time and effort I put in and the success of the company.
Heard of Enron?
The best example of large investments in company stock going wrong is with the company Enron. Enron employed nearly 20,000 employees at the time of its collapse and many of those were invested fully in company stock. For me, the risk of having your entire 401(k) in one company just doesn’t make sense, no matter how safe the company may seem.
When it Makes Sense
I’ve never worked for a startup but I know that many startups offer options or stock-based compensation. So in essence, you’re trading less money for the chance at huge returns if your company succeeds. A lot of startups fail but for the ones that don’t, stock compensation could be a huge windfall.
Another type of stock compensation is through an employer stock purchase plan. Most companies will offer a discount in the range of 10 to 15% off their stock price at the beginning or end of a 6- or 12-month period (whichever price is lower). Some companies will allow you to sell the stock immediately (in which case the purchase plan is a no-brainer) but others will force you to hold the stock for six months. Either way, I think ESPPs are great investment options since the discount will typically outweigh any potential losses.
In summary, it’s important to keep things in perspective when investing in company stock. You don’t ever want to hold a significant portion of your portfolio in company stock but sometimes it might not be worth the hassle if it only makes up 1 or 2% of your portfolio.
Readers, do you own any company stock? If so, why and how did you acquire it? What would you do if your company auto-invested part of your 401(k) contribution in company stock? Would you make a biweekly transfer?
Harry Campbell is a staff writer for the College Investor and runs his own personal finance blog at Your PF Pro where he talks about everything from saving money at Chipotle to asset allocation for retirement. Harry currently resides in San Diego, CA and also works full time as an aerospace engineer and part time as a club volleyball coach.