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401(k)s And Company Stock: How Can We Encourage Diversification?

Author

Listed:
  • Alicia H. Munnell

    (Center for Retirement Research)

  • Annika Sunden

Abstract

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.

Suggested Citation

  • Alicia H. Munnell & Annika Sunden, 2002. "401(k)s And Company Stock: How Can We Encourage Diversification?," Issues in Brief ib-9, Center for Retirement Research.
    • Handle: RePEc:crr:issbrf:ib-9
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    File URL: http://crr.bc.edu/briefs/401ks-and-company-stock-how-can-we-encourage-diversification/
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    Cited by:

    1. Choi, James J. & Laibson, David & Madrian, Brigitte C., 2004. "Plan Design and 401(K) Savings Outcomes," National Tax Journal, National Tax Association;National Tax Journal, vol. 57(2), pages 275-298, June.
    2. James M. Poterba & Joshua Rauh & Steven F. Venti, 2005. "Utility Evaluation of Risk in Retirement Saving Accounts," NBER Chapters, in: Analyses in the Economics of Aging, pages 13-58, National Bureau of Economic Research, Inc.
    3. Gordon L Clark, 2003. "Pension Security in the Global Economy: Markets and National Institutions in the 21st Century," Environment and Planning A, , vol. 35(8), pages 1339-1356, August.
    4. James J. Choi & David Laibson & Brigitte C. Madrian, 2005. "Are Empowerment and Education Enough? Underdiversification in 401(k) Plans," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 36(2), pages 151-214.
    5. James M. Poterba, 2003. "Employer Stock and 401(k) Plans," American Economic Review, American Economic Association, vol. 93(2), pages 398-404, May.
    6. Greco, Luciano G., 2006. "The optimal design of funded pensions," LSE Research Online Documents on Economics 24519, London School of Economics and Political Science, LSE Library.

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