Investment education tools provided by corporate 401(k) plan sponsors are improving measurably, from explaining historic volatility and risk-return relationships to the importance of diversification and tenets of long-term investing. However, one asset class - company stock - is almost never represented in its true light. Sponsor and vendor educational materials rarely discuss the volatility of company stock by comparing the performance of a single stock with that of a diversified portfolio.
Of nine 401(k) plan guidebooks sent to Pensions & Investments for review during the last year, only one discusses the potential risk of investing a significant portion of account assets in company stock. Even that two-page treatment, buried in the middle of the 244-page book, isn't especially hard-hitting. Publishers of these guidebooks tout them as a great "objective" source of information. Many plan sponsors give them to employees as part of an investment education program. But even these guides, independent of influence from sponsors and service providers, don't impress on plan participants the dangers of overinvestment in a single security.
A P&I survey found defined contribution plans among the top 1,000 employee benefit plans averaged a 23.3% allocation to company stock last year. Consultants and portfolio managers generally recommend investing no more than 5% of total portfolio assets in a single security. So why isn't this basic tenet of diversification emphasized to defined contribution plan participants? Why do employers continue to make matching contributions in company stock and lock employees into that investment? Many companies, say consultants, are beginning to institute controls on the amount an employee may invest in company stock, but that limit is usually 25% or 50% of an account balance. "If you are going to offer more choices, more education, you have a real problem with company stock," said Jim Klein, principal, Towers Perrin, New York. "If you say something real about company stock, it's not going to be nice."
The problem boils down to a conflict of interest, say consultants. On the one hand, a company has a cheap way to make its matching contributions to the 401(k) plan and to build a base of friendly shareholders. Companies are worried that warning employees about the dangers of over investment in company stock might send a mixed message."Have faith in your company, but don't invest too much in it," just isn't palatable for many corporate treasurers.
On the other hand, employers seeking safe harbor from fiduciary liability under the Department of Labor's 404(c) regulations are obliged to disclose the volatility of their 401(k) investment options. Logically, company stock should receive the same level of disclosure as mutual funds options do and employees should be as free to invest, or not invest, in that asset category as in any other in their 401(k) plan.
To meet the spirit, as well as the letter of the law, corporate defined contribution plans should provide at least as much information about company stock as other options and should eliminate restrictions on trading out of the stock, if employer matches are made in company stock.
Plenty of stories abound about employees who retire rich because of their company stock investments. But the unheralded story may be the more important one - that of the unlucky employee in a volatile industry who retires with 50% or more of his 401(k) plan in company stock at the moment it reaches its nadir. Rather than let employees rely on luck, employers need to provide full 401(k) plan education that teaches traditional portfolio management techniques to the fullest extent, including honest treatment of the volatility of company stock.
