Free to seek a safer nest egg

This article originally was published on Sept. 7, 2003.

Kansas City area companies are having second thoughts about telling employees how to invest for retirement.

Since the start of last year, five have unlocked millions of dollars in their employees’ 401(k) accounts — freeing employees to sell the shares and invest in less risky mutual funds that the plans also offered.

The companies previously had required the money to be invested in their own shares.

Many employees, however, aren’t selling.

At Cerner Corp., for example, “associates did not move much money out of Cerner stock though they had newfound freedom,” said David M. Evans, director of compensation and benefits at the North Kansas City company.

Cerner eased limits a year ago, making it easier for employees to sell Cerner shares inside the plan. Still, employees had more than half their 401(k) dollars riding on Cerner’s stock as 2002 ended.

Companies report changes to their 401(k) plans in 11-K filings with the Securities and Exchange Commission.

Reports of 17 area companies’ 401(k) plans for the past two years showed several plans held concentrated bets on the companies’ own shares though employees were free to move the money into other investments.

The inaction violates a widely preached, and in some cases painfully learned, tenet of investing: Don’t keep all your eggs in one basket.

Aquila Inc. employees felt the sting of a concentrated bet last year.

They began 2002 with 56 percent of their 401(k) money invested in Aquila’s stock. The energy company had contributed the shares but wouldn’t let most employees sell the stock to invest in the plan’s other choices.

The employees finished the year $200 million poorer for it, as the stock fell from more than $25 to less than $2 a share following financial setbacks and a restructuring at the company. After the stock drop, Aquila unlocked the shares in January this year.

To avoid the risk of dramatic losses, financial advisers recommend limiting how much money goes into any company’s stock — especially in the company that provides your paycheck and benefits. But those limits vary, with some advisers allowing 20 percent and others only 5 percent.

Unlocked but loaded

The 2001 collapse of Enron Corp. wiped out many employees’ nest eggs because the plan was heavily invested in Enron stock. It also drew attention to other 401(k) plans stuffed with the employers’ own shares.

Lawmakers proposed limiting employers’ stock in such plans or at least allowing employees to sell the shares. Although Congress never acted, some companies did.

“The consensus out of the Enron debacle is that people should not be locked in” their company’s shares, said Alicia Munnell, director of the Center for Retirement Research at Boston College.

The Enron example prompted LabOne Inc. to unlock employees’ LabOne shares in their 401(k) accounts, said John McCarty, chief financial officer of the Lenexa-based company.

Like many companies, LabOne contributed its shares to employees’ 401(k) accounts and blocked employees from selling the shares. In a change of heart, the company unlocked half those shares last year, for employees who had worked at LabOne at least three years, and unlocked the rest of their shares early this year.

Employees mostly kept the stock, said Randy Shelton, LabOne’s director of payroll and benefits.

Shelton said employees sold 14 percent of the shares that were unlocked last year. That left them, collectively, with almost half of their 401(k) money invested in LabOne as 2002 ended. Shelton said they have since sold 7 percent more.

Collins Industries Inc. in Hutchinson, Kan., similarly unlocked its shares in the 401(k) plan last year. But employees ended the year with 48 percent of their money invested in Collins stock.

Westar Energy Inc. unlocked its company stock last year, though the shares had not been a large portion of the retirement plan.

Shares of Commerce Bancshares Inc. accounted for 59 percent of the 401(k) plan as this year began, though employees have been free to sell the shares for years.

At Sprint Corp., the company’s FON and PCS shares accounted for 37 percent of the 401(k) plan at the end of 2002. That was down from 51 percent at the start of the year largely because the stocks’ prices fell sharply.

Sprint locks up the shares it contributes to the plan. In June, however, Sprint told employees that, over the next five years, it will unlock shares it already has contributed. Shares the company contributes in the future will be locked up for three years before employees will be able to sell them and move the money into other investments in the 401(k) plan.

Cerner still requires its contributions to the 401(k) plan to be invested in Cerner stock. The change it made last year had lifted restrictions on when employees could sell the Cerner shares they had bought with their own contributions to the plan.

Idle hands

Companies offer various reasons for locking parts of employees’ 401(k) accounts in the company’s own shares.

They said the stock motivated employees to work harder and aligned their interests with shareholders’ interests. Or they said giving stock was cheaper than giving cash, or at least kept the cash available to finance company growth.

There may be less logical reasons that employees make concentrated bets on their employer’s stock or stay concentrated after shares are unlocked.

Munnell said inertia is the biggest reason employees remain heavily invested in the company where they work though the company has unlocked shares inside the 410(k) plan.

It doesn’t matter that employees have seen their counterparts at Enron, Lucent Technologies Inc., Aquila and other companies lose heavily in their employer’s shares.

“We’ve had so many obscene examples and it doesn’t spur people” to diversify, Munnell said.

An August 2002 report from the Pension Research Council of the Wharton School at the University of Pennsylvania offered other reasons.

For one thing, the study said some employees might not understand the risk they take by investing heavily in their employer’s stock.

The study cited a 2002 survey by the Vanguard Group, which sells mutual funds and manages many companies’ 401(k) plans. Vanguard had asked employees in 401(k) plans to rate the riskiness of their investment choices.

The study said employees “properly” rated stock in an individual company as riskier than a mutual fund that owns many companies’ stock — except when the individual company was their employer.

“They considered their employer’s stock as less risky” than the broadly invested mutual fund, the report said.

Financial planner Bill Hoeschele in Lenexa said clients sometimes argued that they knew more about their employer and its stock than others, essentially being an informed insider.

“They think they have better insight, but they don’t,” Hoeschele said.

Hoeschele points out the lessons from company failures such as Enron and stock crashes such as at Aquila. He tries to talk clients into limiting their employer’s stock to no more than 10 percent or 20 percent of their investments.

“Even 20 percent is high,” Hoeschele said.

Kevin McGrew, a partner at Wealth Management Advisors Inc. in Leawood, sets an even lower threshold for employers’ stock.

“We would like to see no more than 5 percent concentration in any one stock,” McGrew said. “Sometimes, you shouldn’t have any” company stock.

McGrew said managers of nondiversified mutual funds, which specialize in making concentrated bets, rarely put more than 10 percent to 15 percent of the fund into any one company.

“Even that’s not for very long,” McGrew said.

Such limits apply to all of the stock an employee owns in the company, not just the 401(k) shares. Many companies also offer stock options to employees or sell shares at a discount through employee stock purchase plans.

Some companies with 401(k) plans also have employee stock ownership plans, called ESOPs, that increase how much of an employee’s investments are riding on the company’s shares.

At DST Systems Inc., for example, the Kansas City company’s stock accounts for relatively little of the two 401(k) plans that cover employees. But the ESOP holds mostly DST shares.

The three plans combined had about a third of their money invested in DST stock at the end of 2001, based on the most recent information available on the ESOP’s holdings.

Some 401(k) plans, such as at Commerce, have a lot of company stock because the company folded its ESOP into the 401(k) plan.

McGrew and Hoeschele offered different advice on how to deal with any excess employer shares in a 401(k) plan.

Hoeschele said he would be comfortable taking several months, up to a year, to move the excess into other investment choices.

McGrew said not to wait. He suggested selling all of the excess employer shares immediately and parking the money in a low-risk money market mutual fund, which most 401(k) plans offer.

Then, McGrew said, it would be safe to take some time to move the money into other investments in installments.

Hoeschele said the timing is less important than the task.

“In either case, whether they do it quarterly or all at one time, they should do it,” he said.

Tough sell

Financial planners admit clients don’t always follow their advice.

“It’s really hard for people to do what I’m suggesting,” Hoeschele said. “That’s the emotion kicking in.”

Clients are particularly reluctant to sell when their employer’s stock price has gone up.

Employees at LabOne, for example, know that their company’s stock has done better recently than the diverse mutual funds available in their 401(k) plan.

As a group, LabOne employees made $8.3 million on their LabOne shares in the last two years while losing almost $4 million on the stock and bond funds in the plans.

“It’s actually saved our 401(k) plan over the last few years from looking twice as bad,” Shelton said.

Shelton, 47, said he had not sold any of the LabOne shares in his 401(k) account. But he planned to.

When shares recently traded at $24, Shelton said he thought about selling all of the stock “and chickened out.” He would like to get $25 a share.

And when the time comes, Shelton said he would sell all of the LabOne in his 401(k) account. He also planned to keep the amount in LabOne from building up again.

“The investment in one stock is as risky as you can be,” he said. “It takes (investments in) 25 companies to reduce that risk to a manageable level.”

Beyond unlocking employees’ 401(k) holdings, LabOne will provide employees with online financial advice through a company called Financial Engines. The company’s software makes recommendations based on an employee’s 401(k) account and other information the employee provides.

The software will flag a large investment in one stock, even LabOne shares.

“That’s what we’re counting on,” Shelton said.

Shelton said, however, that not everyone needs to clean out his employers’ stock. He said a 20-year-old or new employee who hasn’t built up a large retirement account doesn’t face the same risk from a concentrated investment as a tenured worker with years of savings.

At the same time, Shelton said, a 64-year-old worker can’t afford to bet heavily on one stock no matter how much risk he would like to take. Even plans that lock up company stock typically unlock shares as employees reach age 50 to 60.

Hoeschele offered one more caution, especially to workers at companies whose stock soared during the boom of the 1990s. He said many stock prices reached unreasonable levels during a speculative bubble that has since burst.

His caution is to not bet on another such ride up.

“Everybody’s dreaming about the company’s stock exploding like it did five years ago. That’s just not going to happen,” Hoeschele said.

This story was originally published September 14, 2017 at 1:31 PM with the headline "Free to seek a safer nest egg."