Let's say that you work for a publicly traded company, and the opportunity arrives to buy stock in the company that employs you. Do you take it? The simple answer is -- it depends.
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One of the arguments in favor of investing in your company's stock involves the fact that you show up for work every day. You may find that you know more about the inner workings of the company better than the average investor because of your job. You may be at least somewhat familiar with the company's business model and are aware of its strengths and weaknesses. In theory, this means you can better assess the company's financial health than a non-employee.
But you might not know as much as you think. Kevin Worthley, a financial planner at the Warwick, R.I.-based Retirement Planning Company of New England, says that an employee may not know what is really going on at the top that could impact the company's future success or failure.
"Under securities regulations, you couldn't buy, sell or trade your company's stock anyway with such information," he says. "That's insider-trading."
Company stock may end up in your 401(k) plan, as some employers use it instead of cash to match contributions. This can work out in your favor if you work for a growing company with a promising future. However, relying too heavily on it to fund your retirement can be bad news.
As the American Association of Individual Investors (AAII) points out, you already rely on your employer for your income and its future for your job security. If something major were to happen to your company, and its stock makes up a good portion of your 401(k), both your current and future financial well-being would be jeopardized.
On the other hand, matched contributions could yield higher returns, and some employers offer company stock to employees at a discount. This is great if the value of your company's stock increases, especially because you originally purchased it at a lower price. But are the potential rewards of having a poorly diversified portfolio worth the risk?
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Learning from the past
Investing heavily in your company stock is a risky strategy. News could break tomorrow that will negatively affect your company, forcing you to watch the value of your once prominent employer's stock crumble before your eyes.
Enron and WorldCom employees learned this the hard way. According to the Financial Industry Regulatory Authority (FINRA), more than half of Enron employees' 401(k) assets were invested in company stock in 2001 and plunged 98.8 percent in value.
The bottom line is that diversified portfolios offer more protection and spread your risk across different markets rather than concentrating it in one sector. As your investment horizon shortens, you run a greater risk of losing a significant portion of your retirement fund if your company were to go under. The older you get, the less time you have to recover from something like this. The AAII says that, in general, one stock should not make up more than 10 percent of your portfolio.