Unveiling The Corporate Giants Behind Your 401(K) Investments

401(k) plans are often invested in company stock, which can pose risks to both employees and employers. Large corporations continue to allow their employees to invest balances in a 401(k) plan in the company’s stock. The percentage of company stock in 401(k) plans has been on the decline in recent years, but heavy concentrations of company stock in such plans pose substantial risks to employees and employers alike.

Diversification - 401k's can be diversified with new rights gained from the Pension Protection Act (PPA) of 2006

The Pension Protection Act (PPA) of 2006 directed the Department of Labor to provide plan participants and beneficiaries sources of information on investing and diversification. Employees have the ability to choose or direct their investments in their workplace retirement plans. The PPA created a number of new laws for pension and retirement plans and made permanent some 2001 laws that were temporary. The Act added Section 401(a)(35) to the Internal Revenue Code (the "Code") to require that a qualified defined contribution plan (other than certain employee stock ownership plans) must allow "applicable individuals" to sell the employer stock held in their plan accounts and reinvest any proceeds in certain diversified investments. The Act also adds a parallel provision as Section 204(j) to the Employee Retirement Income Security Act (ERISA) and a new requirement under Section 101(m) of ERISA that participants be notified of their diversification rights and informed of the importance of diversifying their retirement investments. At least three other diversified investment options must be available to participants for these diversification elections. Each participant in a plan subject to the new rules must receive a notice of the right to diversify at least 30 days before the first date the participant is eligible to diversify. The diversification rights under Section 401(a)(35) are provided under Subsections (B) and (C). Subsection (B) provides that the diversification requirements apply with respect to elective deferrals, employee after-tax contributions and rollover contributions (and earnings on same). An "applicable individual" for this purpose is a participant in a covered plan, an alternate payee who has an account under the plan or any beneficiary of a deceased participant. Subsection (C) provides that the diversification requirements apply with respect to other employer contributions (and earnings on same), and an "applicable individual" for this purpose is a participant who has completed at least three years of service, an alternate payee who has an account under the plan with respect to a participant who has completed at least three years of service or a beneficiary of a deceased participant. The Pension Protection Act of 2006, combined with the Employee Retirement Income Security Act of 1974, is responsible for many of the laws that protect workers’ pensions and retirement savings today. The PPA made it easier for employers to automatically enroll employees in workplace retirement plans, increased how quickly employer contributions to employees’ defined-contribution plans vest, and gave employees the right to diversify out of employer stock in their retirement plans.

Company stock - Employers allow employees to invest in company stock, which is risky and concentrated in large corporations

Many US employers, particularly large companies, continue to allow their employees to invest balances in a 401(k) plan in the company’s stock. This is a risky investment, as heavy concentrations of company stock in such plans pose substantial risks to employees and employers alike.

The percentage of company stock in 401(k) plans has been on the decline in recent years. This trend is rooted in misfortune. When shares of the Enron Corporation crashed following the company’s 2002 bankruptcy, 62% of the assets in the Enron 401(k) plan were invested in Enron stock.

The enactment of the Pension Protection Act (PPA) of 2006, plan participants gained new diversification rights.

Stock funds are also classified based on the size of the company, which is represented by “market capitalization.” Stock funds made up of investments in very large corporations would be considered “large cap”, while the funds made up of smaller companies is represented as “small cap.”

The value of stocks fluctuates with the market. Stock funds made up of investments in very large corporations would be considered “large cap”, while the funds made up of smaller companies is represented as “small cap.”

Large cap - Stock funds in large corporations are considered large cap

Stock funds are categorised based on the size of the company, which is represented by market capitalisation. Stock funds made up of investments in very large corporations would be considered large cap, while the funds made up of smaller companies is represented as small cap.

Many US employers, particularly large companies, continue to allow their employees to invest balances in a 401(k) plan in the company’s stock. It’s a risky investment, as heavy concentrations of company stock in such plans pose substantial risks to employees and employers alike.

The percentage of company stock in 401(k) plans has been on the decline in recent years. The trend, however, is rooted in misfortune. According to the Congressional Resource Service, when shares of the Enron Corporation crashed following the company’s 2002 bankruptcy, 62% of the assets in the Enron 401(k) plan were invested in Enron stock.

Stock funds are also classified based on the industry they represent. Tech stocks are a popular category of investments in growing tech companies, for example. You may see some stock funds that are labeled as “domestic”, meaning they represent American companies. “Internationalrepresent foreign companies.

The value of stocks fluctuates with the market. Aggressive growth funds are always looking for the next Apple (AAPL) but may find the next Enron instead.

Enron Corporation - Enron's bankruptcy led to 62% of assets in the Enron 401(k) plan invested in Enron stock

Enron employees held nearly 60% of their retirement assets in company stock. As the company sank toward bankruptcy, Enron was changing plan providers, which prevented employees from selling shares. Simultaneously, Enron executives with personal holdings outside the 401(k) were unloading their shares.

Enron's bankruptcy led to 62% of the assets in the Enron 401(k) plan being invested in Enron stock. Thousands of Enron employees lost most of their retirement savings when the company’s stock plummeted and Enron filed for bankruptcy. Shady accounting practices and fraud may be ultimately responsible for Enron’s failure, but the employees’ losses were made much worse by the nature of their retirement plans and the extent to which their investments were concentrated in their employer’s stock.

Enron, like many other public companies, matched pretax 401(k) contributions with its own stock and limited the ability of employees to sell that stock. The Enron scandal was a series of events involving dubious accounting practices that resulted in the 2001 bankruptcy of the energy, commodities, and services company Enron Corporation and the subsequent dissolution of the accounting firm Arthur Andersen. The Enron scandal resulted in a wave of new regulations and legislation designed to increase the accuracy of financial reporting for publicly traded companies.

Investment returns - Big money comes from the last 5-10 years of investment returns

K) plans are invested in the market, which means that the investment returns come from the last 5-10 years of investment returns. Large companies allow their employees to invest balances in a 401(k) plan in the company’s stock. The percentage of company stock in 401(k) plans has been on the decline in recent years, but heavy concentrations of company stock in such plans pose substantial risks to employees and employers alike.

Stock funds are made up of investments in very large corporations, which are considered “large cap”. Stock funds are also classified based on the industry they represent, such as tech stocks or domestic and international funds. The value of stocks fluctuates with the market.

Value funds are in the middle of the risk range and invest primarily in solid, stable companies that are undervalued. Balanced funds may add a few more risky equities to a mix of mostly value stocks and safe bonds, or vice versa. Aggressive growth funds are always looking for the next Apple (AAPL) but may find the next Enron instead.

The Pension Protection Act (PPA) of 2006 gave plan participants new diversification rights. The good news is that the percentage of company stock in 401(k) plans has been on the decline in recent years. When shares of the Enron Corporation crashed following the company’s 2002 bankruptcy, 62% of the assets in the Enron 401(k) plan were invested in Enron stock.

The trend, however, is rooted in misfortune. More specifically the big money comes from the last 5-10 years of investment returns. Because no one invests their 401k money in just a cash account, they invest it into the market dude, that’s the whole point of the program, tax-free investment growth.

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