7 Things You Need to Know About Investing in Company Stock

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If you are employed by a public company, there is a chance that you will be offered the option to invest in company stock in your 401(k) or purchase company shares at a discount. This can be a nice perk for employees, and a possible incentive for them to work hard and remain loyal to the company.

But investing in company stock is not without its pitfalls. You may recall stories about workers from Enron, Lehman Brothers, and other firms who lost much of their retirement money when those companies went bankrupt.

If you have the chance to purchase company stock, consider taking advantage of it. But also be aware of some of these key pieces of information beforehand.

1. Sometimes you get company stock for free or at a discount

Companies distribute stock to employees in a number of different ways. Sometimes, it's simply given to workers as part of compensation plans. Other times, it's in the form of options that allow workers to buy shares at a certain price. (For example, you may be able to lock in shares at $45 per share even if they are selling at $60 on the open market.) This can be a nice benefit to employees beyond the normal salary, and it's often designed as an incentive to make them feel more invested in the company's success. If the company does well and share prices rise, employees can benefit financially. But the flip side is also true. If the company performs poorly, you could lose.

2. You already depend on your company

Your financial well-being is already heavily dependent on the success of your employer. The company pays your salary, offers you health benefits, and may match your contributions to your retirement plan. If you accept company stock, even more of your financial future is tied up with the health of the company.

"By using one's financial capital (i.e. 401(k) balance) to purchase employer stock, an individual is effectively over-allocating to the future success of his or her current employer," Morningstar said in a research report on the issue. This may be fine when the company is doing well, but bad news if the company is struggling. If you do accept company stock, take steps to diversify your income and investment holdings so your success and the company's success are not so intertwined.

3. Company stock should not be your sole retirement strategy

Many people have found themselves in trouble when they've decided to put all of their retirement plan contributions into company stock. Or, they've accepted company stock as compensation without contributing their own money into a diverse set of investments. This is dangerous because it places all of your retirement money into a single company that could go bust at any time.

This is what happened with many Enron employees, who were left with nothing for their retirement when the company collapsed. Company shares should only be viewed as one component of a broader investment portfolio that includes a healthy mix of stocks from various industries and asset classes.

4. There may be tax implications

Unless your employer allows you to buy company stock as part of a tax advantaged retirement plan, you will be asked to pay taxes on any dividends you earn, and on capital gains when you sell. So keep this in mind at tax time.

If you own a large amount of company stock, those shares could represent a sizable tax bill that you will have to plan for. And if you decide to sell shares shortly after acquiring them, remember that capital gains could be taxed at the normal income rate rather than the long-term capital gains rate, which is lower.

5. Companies that offer stock aren't necessarily stronger

You should not assume that a company's stock will perform well just because they are offering shares to you. In fact, there is some evidence to suggest that companies that dish out a lot of stock to employees actually perform worse than companies that don't. You may feel like you are cheating if you invest in companies other than your own, but your future self will thank you.

6. You may end up with more company stock than you realize

If you've acquired company stock over the years and it's performed well, you may find that over time it has taken on a disproportionate share of your investment portfolio's value. On one hand, it's good that the share price has risen, but now your portfolio is way out of balance and a big bulk of savings is at risk if those shares drop in value.

It always makes sense to check your portfolio frequently and rebalance when you find yourself overweight with any one investment. This is especially true when dealing with company stock. As a general rule, avoid letting company stock make up more than 10 percent of your total investments.

7. Owning company stock has become less popular

Offering company stock used to be more common than it is now among organizations looking to attract top talent. The percentage of company stock in 401(k) plans has declined over the last decade. Back in 1999, company stock made up about 17 percent of the assets in 401(k) plans, but that figure has declined to 7 percent, according to the Employee Benefit Research Institute. And it appears that newer employees are less likely to place company stock in their retirement plans; EBRI reported that just 30 percent of new workers placed company stock in their 401(k) plan, compared to 44 percent of all planholders.

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