Employer Stock: Blessing or Curse?

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Is company stock making a comeback?

A new study by Charles Schwab (Stock Quote: SCHW) finds many companies renewing emphasis on using their own stock to reward and motivate employees.

About 25% of the 200 firms polled said they would increase stock-related benefits in the next year, while 68% said they would maintain their stock plans at current levels despite economic woes causing firms to trim other forms of pay and benefits. The survey covered stock offered through options, through restricted-share programs that vest over time and through performance-based rewards.

Other studies suggest that many employees are starting to increase employer stock purchases through 401(k) plans.

Which leads to the question: Are employees taking too much risk?

The strategy of investing in employers' stock got a black eye in the Enron collapse of 2001, when thousands of the energy company’s employees lost both their jobs and retirement savings.

Afterward, many financial advisers urged employees to lighten up on company stock. The Pension Protection Act of 2006 gave employees with three or more years on the job the right to sell shares obtained from employer matches of 401(k) contributions. Employees can sell shares acquired with their own contributions at any time.

Still, about 10% of 401(k) assets are held in company stock, and some employees keep the bulk of their accounts in employer shares, according to the Employee Benefit Research Institute.

Most experts argue that individual investors, especially those who are not savvy stock pickers, should have no more than 10% of their holdings in any single stock. On the other hand, many people do get rich with holdings in a single company. Just ask the employees who got in on the ground floor of Microsoft (Stock Quote: MSFT).

The 10% rule generally applies to the investor’s entire portfolio. There may be nothing wrong with having 20%, 30% or 40% of your 401(k) in company stock if you have lots of well-diversified holdings outside of your 401(k).

Still, employees are wise to look at employer stock just as they would any other firm’s. In other words, would you buy it if you didn’t work there? If the answer is “no,” you should probably steer clear of it. If the firm offers shares at a discount, you can sell soon after getting them, pocketing a quick profit.

If the answer is “I don’t know,” you may not be practiced enough at stock analysis to bet on individual stocks from any company. This is why most small investors are better off with mutual funds, which leave the stock picking to the pros.

Many employees invest in their own firm out of a sense of loyalty, or because they feel they know the firm well. Many employers offer company stock because they think a share of ownership gives employees an incentive to work harder. But employees should put these considerations aside and focus on expected returns.

For an investment in employer stock to make sense, it has to offer a better return than you can get elsewhere. In fact, it would have to do considerably better to offset the risk of having so many eggs in one basket.

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