We’ve talked about diversification here before, and diversification is the lens through which I make the assertion that you shouldn’t (overly) invest in the company you work for. This claim generally is met with resistance and hesitation by most people I’ve talked to about it.
Many of us, when we start with a company, are told that we can invest in the company’s stock through a 401k or direct stock purchase program. We hear co-workers talk about the stock price frequently with the implication that they’ve made or lost money that day. We hear the stories and lore about colleagues who have retired based on the company’s stock performance or currently live on the dividends. We hear our bosses and upper-management talk about how our work delivers value to our investors. And, as employees, we’re constantly doing work that we’re very close to – expecting the results to be great, and therefore further the company’s performance.
Diversification, by definition, is the practice of spreading investments among a variety of things. I argue that the time you spend at your job is an investment much like the money we use to buy stocks in the market. Because of this, I believe that most people are already over-exposed to their own company’s performance simply by working a full-time job – further investing in that company only increases that risk and exposure.
Most people are already dependent on the salary from their job to pay for their housing, transportation, utilities, and entertainment spending. Ideally, a portion of that salary is saved and invested for the future, whether for retirement or otherwise. Because the funding to invest comes from the company, the amount you can invest is directly tied to your salary and expenses (and assuming you have your expenses under control, the only variable left is your salary – which is entirely dependent on the company you work for).
Many will scoff at the idea that investing in your company is a bad idea. But let’s play out a scenario:
Let’s assume your company begins to lose significant market share to a new competitor or you lose a major customer or contract. This downside can impact your personal finances in two ways if you invest heavily in your own company’s stock.
First, if the downturn is significant enough, the stock price can be impacted. This can lead to significant losses in your investment portfolio or retirement account. A major loss can set you back years when it comes to financial planning (another reason I like buying ETFs vs individual stocks). If you held $30,000 in your company’s stock built over 5 years, a 20% loss in value will set you back an entire year of investment. And this year isn’t a one-time set back, but rather you will be lagging your plan by 12 months moving forward.
Second, assuming the downturn was significant enough to cause a 20% decline in stock value, it wouldn’t be a surprise to have the company begin to make cuts when it comes to head count. Everyone likes to assume they are above average when it comes to work performance, but for half the population, this isn’t true. There is a very real chance that you could find yourself without a job as well. If this were to happen, not only would you be without employment, but you would also have a significantly lower pool of investments to draw from to help you bridge the gap in living expenses until you could find new work. And, if do end up having to draw down your investment portfolio to keep the roof over your head, you will be having to sell your holdings at a low point in the stock price – which is likely an unfavorable time to sell. This would set you even further back when it comes to your financial plan.
Let’s play this example through fully. Assume you’re making $60,000 per year after taxes with the $30,000 investment in your company’s stock. You lose a major contact, which causes the 20% decline in stock value and brings on a wave of layoffs, in which you lose your job. Your living expenses are roughly $50,000 per year. Your investment is now worth only $24,000 and you have no salary to cover the $4,200 in monthly expenses. While you begin your job hunt, you are forced to sell your holdings of the company’s stock to pay your bills, giving you less than 6 months to find work before you are out of cash. If you find a comparable job in 4 months, you will start that job with only $7,200 in your investment account.
Now let’s take the same scenario as above, because the loss of a job will set you back financially no matter how you invest your savings. But you can minimize the impact by diversifying your income streams as seen here: Your $30,000 investment portfolio wouldn’t have seen the 20% decline in value, which means you still would have $30,000 when you begin your job search. You still have bills to pay, so you’ll need to sell some investments to cover the time while job hunting, but if you find a job in 4 months, your investment account will be worth $13,200. That’s a $5,000 difference vs the first scenario.
The point is simply this: your income stream is probably 100% dependent on a single company. That, by definition, is lack of diversification. Because of that, investing heavily in the company that cuts your paycheck only furthers your exposure to that company’s risk.
And if you believe you have information that justifies investing heavily in your own company’s stock because of information you have as an employee – you may be opening yourself up to significant insider trading risk.
Diversification is everything. Eric begins his post above talking about it. Most people tell us we should focus on it from the standpoint of investing. It’s hard to think about the stock market without diversification coming to mind. So why do most of us rely almost 100% on one company for most of our income?
It’s no ones fault, but unfortunately, to get access to a lot of the great benefits a company offers (401K, Healthcare, Leave, Vacation, etc.) you have to work full time for that company. After working 40-50 hours a week, many people just don’t have enough time to have another work-based income stream. Sure, we could encroach on our family lives or do something freelance (and many do), but for a lot of us, it just isn’t feasible to do that and still lead the life we want to.
The stories you just heard from Eric are real. A lot of us remember the Enron crash in the early 2000s. Think about the people that had invested their whole careers at that company? Think about the folks who put most of their savings back into the stock? Many of those people were left with nothing, and through no fault of their own except for not diversifying. Companies come and go like clockwork, and we can put ourselves at risk if we are exposed to any particular one.
We can’t always know when bad things are going to happen. What we should do though is assume they are going to happen and then plan for it. If you do that, you’ll be prepared for a wider variety of situations life throws at you. What I would like to do now is add some color to Eric’s story above on some different diversification strategies.
Let’s say you were to take a portion of your income and put it in to real estate. You could do a variety of things with this: buy houses and flip them or acquire a property and rent it out to a homeowner. Assuming you put 20% down and purchase a property at a reasonable price point, you have the opportunity to make some money. While these strategies require some time and effort, over the long-term, you will generally find yourself in a good spot.
Instead of using Eric’s example above where an individual has a mid-career financial crisis, I would like to reference one in retirement. I spend a lot of time worrying about how I’ll maintain financial viability when I am no longer working. If you retire with $1 million in your 401k, but 80% of that is in the stock for the company you worked for, you’re at risk. What if you diversified your retirement strategy to incorporate other forms of income.
Over a 30 year career, it’s reasonable to assume that an individual could sow the appropriate investments to end up with 5-10 rental homes. Assuming you’re on the low end of this estimate, those 5 rental properties, if fully paid off, could net you $10,000 a month at a rental rate of $2000 a month. While you’re more exposed to the general real estate market, this diversification combined with other investments is a nice hedge against a particular company performing poorly.
At the end of the day, Eric is right. Anytime you become reliant on one particular company or income stream, you’re at risk. For most of us, we make our money from one company. Don’t let that put you in a precarious situation because you didn’t plan ahead.