Depositors and investors are not the only ones taking a financial hit from the recent collapse of two regional banks. Many bank employees are taking huge losses in their 401(k) accounts.
The Federal Deposit Insurance Corporation took over Silicon Valley Bank and Signature Bank, making the stock in the banks worthless. The contagion that accompanied the repeated bank runs and market panic led to a steep fall in stock prices in other banks, especially regional banks.
Employees of publicly traded companies often hold employer stock in their 401(k) and employee stock ownership plans. About 19% of the assets in SVB’s retirement plans were in the company’s stock, According to pension and investment, It is not uncommon for as much or more bank employee retirement plans to be allocated to company stock, according to data published by P&I,
Employers used to encourage or even require employees to invest a portion of their 401(k)s and other retirement plans in company stock. Many employers reduced their emphasis on owning company stock over the years, primarily because bankruptcies and significant stock price declines made employers and some executives potentially liable for losses in employee retirement accounts. .
In 1997, approximately 30.6% of 401(k) plan assets were allocated to company stock. Allocation of company’s stock drops to 6.2% in late 2022 Elite Solutions 401(k) Index,
Allocating a significant portion of one’s retirement savings to employer stocks can be risky, as evidenced by the collapse of SVB and Signature Bank.
Individuals have both human capital and financial capital. Human capital is basically your ability to earn income from employment or self-employment. Financial capital is the part of your earnings that you save and invest.
One risk of human capital is that the employer does poorly or even fails. This reduces your earnings at least till you get a new job. The loss of human capital may be permanent if you cannot find a job that pays a comparable amount or problems with a first employer hurt your marketability.
The risks are amplified when a significant portion of your retirement savings are invested in employer stock. Again, both your human capital and investment capital depend on the employer’s success and are at risk if the employer falters. Employees may simultaneously lose their jobs and see a significant drop in their financial capital.
Concentrating retirement savings in one stock is risky, even if you’re not an employee of the company.
When the stock becomes the market leader, concentrated investment can significantly increase returns. Some people have profited in recent years by focusing their portfolios on a few stocks that turned out to be big winners, such as Apple, Amazon, Google and Tesla.
But concentrated investing makes a portfolio more volatile. Furthermore, an investor cannot know everything that happens inside a company and all the forces to which its shares are vulnerable. Some investors who concentrated in a few big winners were happy until shares lost 50% or more of their value in 2022.
Keep in mind that when you own both company stock and a mutual fund in the 401(k) account, the mutual fund may also own shares in your employer.
Some people are more confident when they own their employer’s stock in retirement accounts. They believe that as employees they have a good sense of how the company is performing and will know whether or not it is time to sell.
But the opposite is more likely to happen. Employees with significant allocations to employer stock in their 401(k) plans tend to have lower investment returns than others, According to 2013 research by David Blanchett, In addition, companies whose 401(k) plans have a significant allocation to employer stock tend to have worse stock performance than other companies.
My father worked for AT&T for many years. He took advantage of an incentive offered by the company to buy shares of AT&T stock outright. He still owned the shares when he died, as well as the shares of its spinoffs and successors.
But those shares were only a small part of his net worth. Most of his savings were in investments unrelated to AT&T. Furthermore, when he worked there, AT&T was a regulated utility monopoly and the stock paid high dividends. It was a safer stock than its successors, and the company’s core business was also less risky.
Most of us have heard stories of people who retired too early or too well because they worked at companies with excellent stock performance and invested in a lot of company stock while working there. But those examples are rare. It is more likely that a former employee benefited from stock options than from purchasing employer stock in a 401(k) account.
There are more cases of people getting badly hurt than losing their jobs and a large chunk of their investment capital because they staked their future on a company.
The owner has the benefits of employer stock. But employees should be aware of the risks and avoid risking their financial security on a single company. A good rule of thumb is to limit employer exposure to 5% to 10% of one’s financial capital.
Sometimes you almost have to own some employer stock because employer stock pays 401(k) matching contributions or offers an employer stock purchase discount that’s too good to pass up. In those cases, monitor the percentage of net worth in employer stock and sell some shares if the allocation is too large.
Before you sell the shares, take a look at the tax rules for the sale of company shares in retirement plans, called the net unrealized appreciation rule. You can get a substantial tax break depending on how the sale is handled. It is often worth consulting with a tax advisor to determine whether you may benefit from the NUA rules.
Credit: www.forbes.com /