One of the most common way people invest in the markets is through a retirement account like a 401(k), 403(b), or IRA. In many ways investing in the markets is no longer a way to “get ahead” but a way to not fall behind. If you are not going to be receiving a corporate or municipal pension in retirement, then investing part of your earnings into a tax-deferred investment account can be a smart strategy. Many retirement accounts offer diversified mutual funds that allow you to invest in hundreds, if not thousands of individual companies. But what about the company that you work for? Can you or should you invest it?
If you work for a large publicly traded company and are contributing to your 401(k) then chances are you are already invested in it through the mutual funds mentioned above. But even then, some of these corporations will allow employees to purchase individual shares through employee stock purchase plans. However, most people work for small private businesses which are not publicly traded and don’t typically offer an equity stake. But in some rare cases an employee may be able to contribute to an Employee Stock Ownership Plan or ESOP. These qualified retirement plans are often used by employers as a corporate -finance strategy to align the interests of their employees with those of their shareholders.
ESOPs can be complicated. The amount which you can contribute, accumulate, and withdraw can all vary from plan to plan. Some will allow you to diversify out of the ESOP each year and into a 401(k) all while maintaining tax-deferred status. This amount too, will vary plan to plan, and even year to year. Usually, at the end of very fiscal year the sponsoring firm (the employer) of the ESOP will have the company audited by an independent third party to determine what the shares are worth. Because many sponsoring firms are not publicly traded, the market for their shares is very small and thus a fair-market-value is difficult to obtain. This is known as liquidity risk.
As a financial advisor and fiduciary, I get asked very frequently about ESOPs and whether an employee should contribute. It’s a question that poses a serious dilemma for me. I typically know nothing about the company! Whether you should work for or invest in a company are two different things, of course. The best advice I can usually give is to make sure your investments are diversified and you are not overweight in your company's stock. This goes for a small local business or a mega-cap corporation.
Sometimes people love their work and love working for their company. This is a wonderful thing, no doubt. But it can also cause employees to make emotional decisions when it comes to their ESOPs or stock options. Therefore, it is so important to have guardrails in place to help cope with your biases. The important thing is to be deliberate about how you set your guardrail and have the discipline to abide by it.