401(k) investors ignore Enron's painful lesson

Many have invested more than 50% of portfolio in employer's stock, putting nest egg at risk

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March 26, 2006|By SUZANNE COSGROVE | SUZANNE COSGROVE,CHICAGO TRIBUNE

Much has changed in corporate America since Enron Corp. imploded in 2001, including a raft of new regulations to try to prevent fraud, but some of its most painful lessons may have been lost on investors.

Despite many Enron workers losing sizable nest eggs when the company went bankrupt - and the constant drumbeat from financial advisers on the benefits of diversification - it appears many employees of large firms are continuing to pack their 401(k) plans with company stock.

David Wray, president of the Profit Sharing/401(k) Council of America in Chicago, said that in 2004, the combined defined contribution holdings of workers at 1 in 8 companies was more than 50 percent in company stock. That's down from 1 in 5 in 1999, but still far too large for many investment experts.

In a 2005 report on 401(k) plans by Hewitt Associates that looked at more than 2.5 million eligible employees, company stock was the single largest holding for the average participant. Large U.S. equity funds came in second, Hewitt said. The Hewitt study found plan participants held an average of 26.5 percent company stock in 2005, with just over a quarter of the participants holding half or more of the total in their employers' shares.

The study also found 28 percent of participants 60 or older held at least half their plan balances in company stock - at a time when experts strongly urge diversification against risk as workers approach retirement.

"Familiarity tends to breed complacency," said Christopher Jones, chief investment officer at Financial Engines, a Palo Alto, Calif., provider of 401(k) managed accounts. "Employees feel more comfortable with the stock because they know the managers, know the CEO. ... But unlike a mutual fund, individual companies can go bankrupt. ... Employees of Enron, WorldCom and Global Crossing [can attest to that]."

"The biggest mistake employees can make is to be overly compensated" in company stock, Jones said. That option "can be OK in small doses," but an exposure of more than 20 percent would be a concern, he said.

Analysts point out that even the seemingly most rock-solid blue-chip companies can fall on hard times, with their stocks never recovering. Lindsey Wilkins, a principal at Edward Jones in St. Louis, suggests 10 percent should be the limit for any one stock.

Wilkins, who specializes in retirement issues, said the lopsided accumulation of company stock in 401(k) plans often could be attributed to the "human aspect" of investing. Workers sometimes worry that they are being bad employees by paring back their exposure to company shares, she said.

And for years, companies who matched employees' 401(k) contributions often did so in company stock, complete with restrictions on how quickly that stake could be diversified.

In addition, experts said, an employee may not fully understand how to gauge a portfolio's risks. Companies are responding by providing more education and, in some cases, even restricting or eliminating company stock in their 401(k) holdings.

"Company stock is a unique security in a 401(k) plan," Jones said. "The risk characteristics [of company stock] are very different than of mutual funds," he said. "The common perception is that stock is less risky, but really, it's the complete opposite."

But different companies pose different levels of risk.

Jones said a big diversified company like General Electric Co., for example, which has a long track record and several different kinds of businesses, is "kind of like a mini mutual fund," compared with a new tech company that may have only one product where both the upside and the risk might be a lot higher.

Even with blue-chip companies, if you compare the performance of a randomly picked stock from the Standard & Poor's 500 with that of the S&P 500 index over the long term, the index would do better two-thirds of the time, Jones said. "If it declines 20 to 25 percent, that's a really bad year for the S&P 500, but individual companies go down 20 percent all the time," he said.

The performance of an individual 401(k) also depends on what is done with the rest of the money. Nevertheless, "it would be more reasonable to hold 5 percent to 10 percent company stock, and spread the rest of the portfolio, and investment risk, across different asset classes," Jones said.

That's an option more readily available than it used to be.

Wray said that a 1996 study by the Profit Sharing/401(k) Council found that all 28 companies with 5,000 or more employees in a survey it conducted required employees to hold company stock until they were 50 or older if the firm's 401(k) match was made in company shares.

In 2005, Hewitt said, 46 percent of plans that invest employers' matching contributions in company stock allowed its participants to diversify or transfer those funds at any time.

There is a "gradual trend [among plan sponsors] that is resulting in lower restrictions," said Lori Lucas, Hewitt's director of retirement research.

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