When It Comes to Your 401(k), Don’t Just ‘Set It and Forget It’
by E.A. Mann
A few years ago, my 401(k) started to exhibit strange behavior. I check my statement about once a week, and at the time, I noticed that my balance was dipping and rising, and I had no idea why.
Despite personal finance being a hobby of mine, I don’t really follow financial markets, and I don’t put much research into my investments. You could say I’m uninformed by design, my thought being that if I started to educate myself I’d feel just enough hubris to go out and lose all my money. I was, and still am, fairly proud of my current investment strategy: pick a risk profile, invest regularly (and automatically) in diversified, low fee products, and ignore the financial noise.
But my 401(k)’s crazed flight worried me because, like for a lot of people, it’s my best chance at any kind of retirement. So I ran some cursory checks: Was the S&P 500 soiling itself? Nope — the S&P was modestly up. Was the Federal Reserve making some kind of inside baseball moves that I only pretend to understand when I’m drunk at dinner parties? Wrong again.
Then I checked my company stock. The three-month line graph of performance resembled a seesaw ride taken by a particularly sugared up first grader. Running 401(k) statements for different time periods confirmed that my investment in company stock was causing the majority of my investment swings.
See, like a lot of companies, my 401(k) does an employer match. This is the “free money” that everyone says you’re foolish to turn down. And they’re right; never turn down free money. But that’s usually where the advice ends, and I worry about that, because it hides a pernicious fact: lots of companies match in their company’s stock, and in almost every case keeping this stock is a terrible idea. My company does this. All of my matching funds go into something called ESOP, which is nothing more than company stock and some cash holdings. In my case, my company’s difficulties were having an outsized effect on what should have been a fairly safe, long-term retirement nest egg. I rarely speak without caveat, but I’ll say this directly: If you have more than 10 percent of your 401(k) in your company’s stock it’s a problem, and you need to fix it.
There are many reasons for this. The first is diversification. Every sane financial analyst will tell you that a diversified portfolio will protect you from the ups and downs of any one piece of the economy, be that a country, a sector, or a company. Your 401(k) investment options are a buffet of diversified options: most of them contain dozens or even hundreds of individual investments specially picked by fund managers after careful quantitative analysis. Your company stock, on the other hand, is one stock picked by your company because it is your company.
And this company match can grow to be an outsized portion of your total 401(k). By the time I discovered my error, company stock accounted for 30 percent of my total portfolio. This is the equivalent of exempting kitchen fires from your homeowner’s insurance and then cooking exclusively with a turkey fryer.
You might say, “Yeah, but my company is great and I believe in them.” It doesn’t matter what company you work for. It could be Apple. It could be Exxon Mobile. These are the two most profitable companies of the past five years, and it’s still a terrible idea to own their stock equal to 30 percent of your portfolio. I’m now at about 10 percent, but I’m seriously considering 0 percent. It’s just too risky a bet to make with a retirement fund. If you have a “just for fun” investment account, you can invest it all in Apple stock and you’ll hear no complaints from me. Heck, you can invest in lead balloons. Just don’t pretend it’s anything other than a modestly informed bet.
Lastly, imagine a scenario in which your company goes out of business. It might be large and successful, but the field of capitalism is littered with the skeletons of large, successful companies. Obviously, if your company goes out of business, you’re out of a job. Your 401(k), however, is yours to transfer over to your next employer. Which is great news, except that now it’s significantly lighter because your company’s stock just tanked. Much as we’d like it to be otherwise, our jobs already pull the marionette-strings of our financial life, and it’s insane to give it further influence.
Fortunately, it is illegal for a company to force you to keep your company stock. Sometimes there are vesting periods where you don’t fully own your investment for a period of time. And sometimes you can only trade out your company stock quarterly. But in the end, you can transfer it, and you should fight the warm, sleepy embrace of entropy and do so.
As I explained above, I am not an investment expert, and I wouldn’t purport to tell you where to move this money. You need to research your individual plan and make the decision that’s right for your investment strategy (and you should probably dollar cost average, whatever you decide). But the “set it and forget it” philosophy of 401(k) planning should not be synonymous with ignorance of said plan. Our chances of a long, comfortable retirement are slim enough as it is, and we can at least try to mitigate the obvious risks. Let’s put away the turkey fryer, people.
Previously: “Why My Cat Has a Savings Account”