Monday, December 7, 2009

Steer away from company stock

Every Monday, we answer a question from a reader on our blog. This week, we're answering a question from a connection on Facebook. If you'd like to pose a question to us, post it in the comments section or DM us on Twitter. We're @family_finances.

QUESTION: How often should we rebalance the investments in our 401(k)? I wrangle with this a lot and I know many people who just dump everything into their company stock and sit back. (Good luck.) What's the right strategy?

ANSWER from Dan Danford: Company stock is a terrible choice. I once worked at a bank where almost everyone "directed" their profit sharing balances into bank stock. Long-time regional banking group, with a decades-old record of paying "rising dividends." Eighteen months after I started there, the bank failed (no fault of mine, though!) and employees I know lost their entire retirement savings. Sounds like Enron, right? This nasty scenario repeats itself every few years, and employees, managers, regulators, and legislators all scream in anguish!

But in every case, a brief discussion with any competent advisor would have navigated those portfolios into a diversified model. There are just too many variables beyond your control to hitch your entire retirement savings to one company's wagon. Five to 10 percent in company stock would be the max I'd recommend.

Instead, build a diversified portfolio using index or other low-cost funds, and keep buying no matter the current market environment. Most investment performance comes from the mix of investments in a portfolio. So, most advisors advocate asset targets tailored to an investor's situation - say, 80 percent stocks and 20 percent bonds for an aggressive long-term portfolio. However, that exact mix changes daily as the markets fluctuate and new deferrals are added. So, it pays to re-visit the portfolio occasionally and re-balance if desirable. Some 401(K) plans have the technical ability to do this automatically each month, quarter, or year. Occasional re-balancing makes good sense, and we typically do it with our client portfolios on an ongoing basis (as an advisor judgment, though, without any "automatic" feature).

Strip away the jargon and re-balancing is actually a shift of assets away from the best-performing sectors into the worst. Not everyone wants that, and there is powerful debate within the professional community about the proper frequency and benefit. If a plan offers it, some employees will probably use it. It might even be beneficial during certain periods. For larger balances, though, I prefer some human input into those decisions.

Many 401(K) plans offer "lifestyle" or "target date" portfolios. This is a simple auto-pilot choice where the fund is automatically adjusted for your age and risk tolerance. I recommend them, especially in early years where balances aren't too large. Let professionals adjust the asset targets for you.

Be aggressive, and stick to it. Most people, given their own choices, are too conservative with retirement investments. These accounts are long-term in nature, and aggressive investing is rewarded over lengthy periods. Make aggressive choices, stick to them through thick and thin, avoid tinkering, and conduct a thorough review every two to three years. You'll be amazed how much you can accumulate effortlessly.

1 comment:

  1. Fantastic answer. Thanks for the thorough response. You're right about the company investments. Like Enron, many financial institutions encouraged their people to invest their 401 money in company stock. I think that's a huge mistake.
    The retirement target plans seem adequate for those who are conservative and not willing to take risks, but I'm going full guns and seeking aggressive growth.


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