Thornton's predicament was partially his own doing. "The stock was doing so well, I got greedy," he says. But Lucent is also to blame. The 401(k) plan for hourly employees like Thornton matched every dollar contributed with 66 cents of Lucent stock. It also restricted the stock's sale until Thornton turned 55 last September, when share prices were already beaten down. The restrictions meant that even though he could choose among 16 mutual funds in the plan, at least 40% of his 401(k) contribution automatically went to Lucent.POWDER KEG. Such stories have become commonplace in the recent bear market. According to a new Fidelity Investments study of 7,000 defined-contribution programs, the average plan that offers company stock as an option has more than 31% of total assets invested in it. So much in any one stock is too risky. But considering that an employee's income derives from the same company, it's a powder keg. Companies may lay off workers as stock prices and earnings slide, destroying both jobs and nest eggs.
Part of the problem is the lack of investment education. People know their employer and their industry but often don't understand the stock market. When they invest, they stick with the familiar. "The tools are out there to adequately advise employees," says Michael Scarborough, an Annapolis (Md.) retirement adviser. "But most companies choose not to give them to employees."
The basic structure of many 401(k) plans is also flawed. Employees should not receive a match in company stock and if they do, shouldn't have to hold it for years. According to Fidelity, 11% of companies have age restrictions on stock sales. Some plans are so limited that company stock is the only option. Procter & Gamble employees can own only P&G stock in their 401(k) until they reach age 50, when they can diversify into funds. As a result, 96% of their plan's total assets is in P&G shares. P&G spokeswoman Vicky Mayer says most employees see the stock as a good long-term investment because "it's the leader in its industry." Its three-year annualized return is -7.5%, vs. 2.7% for the Standard & Poor's 500-stock index.
Unfortunately, companies have resisted change. Stock matches prop up share prices and are cheaper for employers than cash; they aren't recognized as a charge against earnings. Also, while employees take on the risk of owning their employer's stock, they don't enjoy the privilege of being shareholders. "What employees are buying in most 401(k) plans isn't really employer stock but a mutual fund that owns employer stock," says Scarborough. "The company, which runs the fund, controls the stock's voting rights."
While employees didn't care about owning too much stock during the bull market, their ire will certainly rise during the bear. "I wouldn't be surprised to see legal action in some of these plans if stock prices continue to decline," says editor Louis Berney of IOMA'S DC Plan Investing, a retirement-plan newsletter. Federal rules say an employer is not liable for losses in its 401(k) so long as employees retain "independent control" of their investment decisions. But how independent can they be when they're stuck owning the boss's favorite stock?
That may be why, according to the Fidelity study, 7% of plans now cap the percentage an employee can have in company stock, the average limit being 25%. That's helpful, but better education and even hands-on investment advice also are important. "Somebody needs to teach employees not to put all of their eggs in one basket," Thornton remarks. Unfortunately for him, that lesson came too late. Staff Editor Braham writes about personal investing.