Sentiment and too much employer stock should have no place in a portfolio
LIKE all massive risks, holding large amounts of stock in your employer is a way to make an investment home run, but an even better way to strike out.
The sad tale of Chesapeake Energy employees in the United States is a reminder of a series of oft taught but seldom learned lessons, namely that when you hold too much of your employer's stock, you imperil your retirement, impair your ability to manage risk and set yourself up for expensive, emotionally driven investment decisions.
A massive 38pc of Chesapeake's main retirement plan's assets were in company stock, despite only 5pc of those assets still being tied up in a vesting period.
It is no wonder that employees jumped at a generous offer to match, dollar-for-dollar, the first 15pc of their salary with shares of stock. What makes a heck of a lot less sense is why they held on to them after they were free to diversify.
While this has been a bit of a disaster for employees, as Chesapeake shares have fallen by nearly half, I'd argue holding more than 5pc of your financial assets in your employer's stock is bad policy whatever the returns and no matter how well run the company.
Considering that 9pc of total US pension assets were still invested in company shares in 2009, according to the Employee Benefit Research Institute -- and many accounts hold no company shares, thus implying greater concentration among those who do -- this clearly is a message some people just don't want to hear.
This is not to say that you shouldn't avail yourself of matching funds if the cost of doing so is holding shares in your employer. Do, but cut back your holding as soon as you are allowed, no matter how bright your company's future may be.
As an employee you already are hugely exposed to your company's future, so holding lots of company stock represents an unacceptable risk.
Companies whose stocks fall sharply have a distressing tendency to lay people off -- and vice versa. You could easily see your retirement or other assets dwindle just as your income falls off a cliff.
As well, many people who get laid off find their career capital is worth much less on the open market than it was within an organisation, meaning that when they do become re-employed it is at a lower salary.
Of course, some people get rich by holding nothing but shares in their employers, but there are also many, probably many more, who work for Lehman Brothers or Enron and see their portfolios turn to dust.
Diversification is basically the single best tool any investor has: it is reliable, it is cheap, and it unquestionably improves outcomes. Use it.
The other great lesson out of this is that grown-up investors take losses. If you have been foolish and held lots of your company's stock and now it is tumbling, for heaven's sake, don't just stand there wishing it back up again. Sell some and cut risk.
All investors have a tendency to become psychologically attached to the top market value of their shares, and many confuse the plans and fantasies they hatch based on those values for promises.
The universe does not care what your pension fund used to be worth. Don't wait for the rebound.
Another reason to avoid holding too much of your employer's stock is our natural tendency to let our emotional connection to a company get in the way of rational decision-making.
No one can fairly evaluate their own children or the company to which they devote most of their waking hours.
This is a version of the endowment effect, a phenomenon described by James Montier of investment management firm GMO. People tend to demand more in payment for something they own than they would be willing to pay for it themselves, endowing it with a special value simply because it is associated with them.
This is a classic mistake in the housing market, where people expect to get top dollar for a tired house simply because they raised a family there.
So it often is with employers. People simply don't have the perspective they need to make good judgments. That's a really useful attitude to have in forming a community or making a company successful, but check your endowment at the door when you visit your wealth manager.
When we know there is a good chance we are labouring under a behavioural fallacy, the best thing to do is impose a rule on yourself and follow it.
Simply put, don't hold more than 5pc of your financial assets in any security, especially if you happen to work for the company which issued it.
James Saft is a Reuters correspondent