You may encounter a client or potential client who has a substantial portion of their retirement portfolio invested in their employer’s stock. Even though they may have done quite well up to that point, these good times could come to a screeching halt and your client may be left holding the bag.
I sometimes encounter potential clients who have a substantial portion of their retirement portfolios invested in their employer’s stock. This includes not only their 401(k) plans but also shares from employee stock ownership plans (ESOP), employee stock purchase plans (ESPP), stock options, and restricted stock, among others. Some of them also instructed their brokers to purchase additional shares on the open market. Sometimes they have done quite well up to our meeting, and they fully expect the good times to last. When I ask why they have invested so heavily in their employer’s stock, the typical response is, “Why not? The stock has performed well so far.”
Hmm. “Why not?” This sentiment always reminds me of a client I met years ago. He worked for a high-tech company and was seeking investment advice. At 48 years old, he had a portfolio worth $1 million, which was impressive. However, most of his investments were in his company’s 401(k) plan, which was entirely allocated to his employer’s stock. He had enjoyed a remarkable run, with the stock price increasing by 86% over a three-year span.
I explained the risks associated with having his entire portfolio tied to a single company,1 especially at one’s place of employment. I recommended diversifying his investments to create a less volatile portfolio, which he could do without tax consequences since all trades would occur within his 401(k). Although he understood my advice, he decided to wait for one more stock split before making any changes.
He is still waiting.
Eighteen months after our meeting, the stock plummeted from a high of $82 to $0.75 per share. To make matters worse, he was laid off and never returned to that job.
Unfortunately, this lesson often needs to be learned anew by each generation.
According to the Congressional Research Service, Enron employees held 62% of their 401(k) assets in Enron stock and lost an estimated $1.3 billion when the company collapsed in 2001. Remarkably, just a year prior, Enron was ranked 25th on the “Most Admired Companies” list and was among the top five for “Quality of Management.”
WorldCom employees lost over $1.1 billion in 401(k) assets when the company declared bankruptcy in 2002. Just a year earlier, Fortune ranked WorldCom as 60th on the list of “Most Admired Companies.”
Similarly, in 2005 and 2007, Fortune named Bear Stearns the world’s most admired securities firm. In 2007, its stock soared to $172 per share. Then, in March 2008, the company was sold to JP Morgan for $2 per share, with 30% of Bear Stearns’ stock held by employees.
Do your clients believe their companies are so well-managed they are immune to significant downturns? Do they point to the press clippings with pride and believe them to be a suit of armor? Many employees at Lehman Brothers, PG&E, Kmart, Sears, Bethlehem Steel, Converse, Kodak, Sunbeam, Pan Am, Global Crossing, Countrywide, Washington Mutual, Lenox, Blockbuster, and Borders thought the same before their companies declared bankruptcy.
That said, an employer doesn’t need to face bankruptcy for an employee’s financial situation to take a hit. In 2019, Brand Finance ranked Boeing as the strongest brand in the aerospace and defense sector, with a brand strength index (BSI) score of 89.5 out of 100. Since then, Boeing has lost over $30 billion in shareholder value, and management has yet to reinstate dividends that were suspended in March 2020. This is not ideal for someone nearing retirement with a large portion of their portfolio in Boeing stock.
In August 2015, Walgreens shares were trading at $97; the company recently agreed to be acquired by a private equity firm for just $11 per share. Warner Bros. Entertainment stock, which traded at $77 per share in March 2021, is now valued at $10. Intel stock is down over 67% since 2020, and Biogen has lost an astonishing $70 billion in shareholder value over the past decade.
In contrast, the S&P 500 Index has returned an average of 10% annually over the last 30 years. This performance could have been easily achieved by investing in the Vanguard exchange traded fund, VOO (S&P 500 Index), with an annual expense ratio of only 0.03%.
A study published in 2021 by Dr. Henry Bessembinder,2 a finance professor at Arizona State University, found that only a small percentage of high-performing stocks account for most of the stock market’s returns. In fact, he discovered that more than half of U.S. and international stocks have lifetime returns that are lower than a risk-free, one-month T-bill.
Longboard Asset Management3 produced a study that revealed investors who select individual stocks face a 39% chance of losing money, a 64% chance of underperforming the index, and a 19% chance that their stock will lose 75% of its value. Only 25% of stocks were responsible for all the market’s gains.
According to Ernst & Young Global Limited, in 1945 the average lifespan of an S&P 500 company was 67 years. Today, that lifespan has decreased to just 15 years, and it is expected to continue to decline. However, your client’s career and retirement may span more than 50 years.
So, when it comes to their financial future and if they hold excessive amounts of their employer’s stock, you may want to channel your inner Clint Eastwood and ask your client, “Do you feel lucky?”
1 Nonsystematic risk is the risk associated with concentrated positions in a particular company, industry, or sector. It can be diversified away and, therefore, offers no financial benefit to the investor.
2 Wealth Creation in the US Public Stock Markets 1926-2019.
3 The Capitalism Distribution.
Kevin P. Brosious, CPA, PFS, CFP, a consultant for Newbridge Wealth Management in Bryn Mawr, Pa. He can be reached at kevin@wealthmanagement1.com.
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