Should I invest in company stock in my 401k?

In an article I authored back in 2010 published in the National Law Review I discussed the risks involved for both companies and employees in allowing employees to invest in company stock within their 401k plans. The company stock becomes availabl

e through an ESOP (Employee Stock Ownership Plan) within the 401k known as a KSOP. Companies can obtain tax benefits through the ESOP as well as buoy its stock. Although ESOPs are numerically most often in small, private companies, it is the larger companies that get press when the ESOP becomes a problem.

When it comes to finances, everybody’s investment goals, strategies and risk tolerance is different, so there is no single answer or basic rule that governs whether you should invest in your company’s stock in your 401k. However, you should know the risks involved and make informed financial decisions. You may want to discuss these risks with a financial adviser. For legal issues about the plan you may need to speak to Texas employment attorneys. The legal underpinnings of how these plans operate under federal laws affect the financial issues and investment risk.

Company stock in 401k plans in Texas

Prior to the enactment of the Pension Protection Act in 2006 (PPA), 401k plans had wide latitude in requiring employees to invest some of their 401k assets in company stock (often company match). PPA changed the rules to limit the employer’s control out of fear that an Enron-like situation. (Where management fooled employees into believing the company was fine and then lost everything.) Enron is the absolute example of the risks involved with investing in your company’s stock.

Although not every company meets its demise Enron-style, similarities exist between Enron and what happens at other companies.

Often, employees receive glowing reviews of the company from upper management. Management does not have a duty to disclose internal problems to employees, even when they are also shareholders, and many of the restrictions on what representations can be made to shareholders do not apply the same way to employee-shareholders. This creates a sometimes overly optimistic view of the company’s future and reward potential.

People also tend to have loyalty to their company and believe it will survive and profit no matter what. These unrealistic expectations, both internal and external, spread across the workforce, adding peer pressure to invest in the company. Next thing you know, everybody is doing it. Although employees are not certain to lose money, they are not making objective financial decisions.

Loss of diversification

One risk of investing in the company stock in the 401k is the loss of diversification. While diversification is not itself a guarantee to profit (or avoidance of loss), investing in a single investment, such as your employer’s stock, means taking considerable risk that this one company is going to do well, perhaps even better than a larger market spread through a diversified investment, such as a mutual fund (also not a guarantee on profit).

When you look at the bigger picture of your finances, you see that you bear risk on a substantial portion of your financial picture on the health and continued profitability of your employer. Your current income and future income stream depend upon the continued operations of that company. Your health insurance, life insurance, pension, retiree health benefits, etc. all rely upon that company continuing to operate.

That is in itself a tremendous investment risk.

Adding to that risk in your 401k hangs more of your future on your employer’s success. That is what makes unrealistic evaluations of your employer particularly dangerous when assessing the investment risk of the company stock.

The converse of all of those warnings is that your employer may go gangbusters, deliver a huge profit to your 401k, promote you, give you bonuses and pay you more than you ever dreamed…or somewhere in between. There are many people who wisely invest in their employer’s stock and walk away with a nice return. You could certainly be one of those people but make that decision from an informed place.