401(k)s And Company Stock: How Can We Encourage Diversification?
Over the past two decades, the private pension system in the United States has shifted from defined benefit to defined contribution plans, and the fastest growing defined contribution plans are 401(k)s. The defining characteristic of 401(k) plans is that employees, rather than employers, bear the investment risk. Currently, many employees hold a significant portion of their 401(k) funds in their companies' stock, which increases the risk of their plans. This investment behavior contradicts standard asset allocation theory. Investing in one stock rather than a diversified portfolio creates more risk without providing any increase in expected returns. In addition, plan participants hold an asset whose value is closely correlated with their own earnings. Due to these two factors, financial experts generally advise against holding large shares of company stock in retirement accounts such as 401(k)s.
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