Here’s a scary statistic: Nearly 58 percent of Enron employees’ 401(k) assets was invested in Enron stock as it fell 98.8 percent in value during 2001, according to the National Association of Securities Dealers (NASD). And here’s a still more frightening piece of information: Even after the fall of Enron, many employees have even larger percentages of their 401(k) assets in their company stock than Enron employees did.
Of course, Enron was an extreme example; most companies don’t flame out in that fashion. Yet, almost all companies go through ups and downs — and, if you’re overloaded on company stock, these “downs” can take a pretty good whack at your 401(k) balance.
To complicate matters, your employer may use various methods to encourage you to make company stock a significant part of your 401(k). For one thing, you may be able to buy the stock for less than the current market price — and it’s hard to resist the temptation of a “good deal.” Also, you may be able to defer a higher percentage of your salary to your 401(k) if you’re buying company stock. And your employer may even choose to make matching contributions in stock, rather than cash.
You need to be aware of this potential institutional “bias” toward using your employer’s stock in your 401(k). Even if your company truly is worth investing in, you’ll be doing yourself a favor by limiting your exposure to company stock. In fact, many experts recommend that you limit company stock to no more than 10 percent of your 401(k) portfolio.
Diversify, diversify, diversify
To avoid getting “bogged down” with company stock, you’ll need to make a conscious effort to spread your 401(k) dollars among the various investment options in your plan. Diversification is the key to investment success outside your 401(k) — and it’s just as important within your plan, too.
Fortunately, most 401(k) plans have expanded their investment choices in the past decade or so. Depending on your plan, you could easily have a dozen or more options, including pooled investments containing stocks or bonds, money market accounts and guaranteed investment contracts (a type of investment that offers preservation of principal and a fixed rate of return).
With all these choices, how can you know the proper way to diversify your 401(k)? Actually, there’s no one “right” answer for everyone. To effectively allocate your assets inside your 401(k), you need to take into account your tolerance for risk and your time horizon. So, for example, if you are by nature an aggressive investor, you’ll probably want to weight your 401(k) more heavily toward the stock accounts. Also, if you’re just starting out in your career, you have a lot of time to overcome any “down” periods in the market, so you might want to invest more aggressively than you would if you were nearing retirement. It’s a good idea to review your 401(k) asset allocation at least once a year to see if it still fits your needs and goals.
Get the most from your 401(k)
By looking beyond your company’s stock, and by allocating your assets across a range of investments, you can help ensure that your 401(k) will pay off for you when it counts — during your retirement.
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