Back in 2004, when a colleague and I wrote a book on 401(k) plans, we dedicated a whole chapter to the dangers of investing 401(k) assets in company stock. During that time, many discussions revolved around the need for Congress to limit company stock investment. However, it was suggested at one meeting that the problem of company stock may resolve itself as target-date funds became the default choice, diverting employees’ attention away from their employers’ stock.
Recent data from Vanguard supports this notion, showing a significant decrease in the percentage of plan sponsors offering company stock, as well as the percentage of participants with company stock. The decline has been particularly steep for participants, with a drastic drop in those offered company stock, those holding company stock, and those with concentrations of company stock over 20%. (Figure 1)
There are three main factors contributing to this decline. First, target-date funds and equity index funds have become incredibly popular and now account for nearly 80% of defined-contribution plan assets. Second, sponsors have recognized the risks associated with employees investing in company stock, as exemplified by the Enron scandal. A 2020 Vanguard study found that over half of companies that previously offered company stock no longer do, and those that do allow immediate diversification. Third, the Pension Protection Act of 2006 expanded diversification rights for participants, giving them the ability to sell their own company stock at any time and employer contributions of company stock after three years.
Despite these factors, there are still 3% of participants who hold more than 20% of their assets in company stock, which is concerning. Owning a single stock significantly increases the risk of a portfolio and offers no potential for higher returns compared to a diversified portfolio of say, 30 stocks. Furthermore, participants with company stock have an asset whose value is closely tied to their earnings, meaning they face the risk of losing not just their job but also their retirement savings if the company runs into trouble.
So why do participants still hold company stock? Generally, they are not savvy investors and underestimate the risk of investing in a single stock. Employees also tend to favor what they are familiar with and may want to take the opportunity to mimic executives who have made fortunes. The problem is compounded when employers match contributions in company stock, as it is often seen as an endorsement of the purchase. In the past, employers valued the ability to match in stock rather than cash, possibly to preserve their cash reserves. However, a series of lawsuits over the past 15 years may have diluted this preference.
This problem of excessive company stockholdings does not exist in defined-benefit plans because ERISA limits company stock holdings to no more than 10% of plan assets. While I used to advocate for a similar limit in defined-contribution plans when I was younger, given the current state of the world, that fight is no longer a top priority on my to-do list.
Let us simply celebrate the progress that has been made so far.
