PRESERVING PENSIONS

April 2002
		Mark Machiz, former Associated Solicitor at the Labor Department during the Clinton administration, and James Delaplane, a vice president of the American Benefits Council, answer your questions on improving retirement security.

Forum Introduction Why do current government regulations limit tax-deductible retirement investments to $3,000? Should our retirement portfolio be diversified, even if it has only Blue Chip stock? How do corporations use employee 401(k) plans to improve their bottom line? Do the Enron and Global Crossing bankruptcies illustrate a problem endemic in corporations and their misuse of retirement funds? How did Enron employees lose their 401(k) savings and what was the "blackout" period in which they could not sell any of their shares? Is that legal?       Online Special: Enron: After the Collapse Feb. 19, 2002: Enron's collapse and its affect on pensions in the state of California. Feb. 11, 2002: The government replaces Enron's pension committee Feb. 1, 2002: Experts discuss the president's pension plan reforms. Jan. 28, 2002: The repercussions of Enron's collapse in its hometown of Houston, Texas. Jan. 18, 2002: Issues and answers about retirement accounts following the collapse of Enron. Dec. 12, 2001: How Enron's bankruptcy is affecting its former employees. Browse the NewsHour's coverage of Business

Sue Watts from Boulder City, NV asks: A good proportion of our retirement funds are invested in a Blue Chip company stock; when we asked a financial adviser why we should put "all of our eggs in one basket," he replied, "It's hard to find a better investment." Should our retirement portfolio be more diversified? Why? Should there be any government regulations prohibiting high-risk investing strategies for tax-exempt retirement accounts? Mark Machiz responds: For goodness sakes, find another financial adviser. Yours is a fraud. Assuming this is truly a Blue Chip company, it is publicly traded and publishes its audited financials which are analyzed by dozens of Wall Street firms. Whatever is known about the company is already reflected in its stock price, including its prospects for future earnings growth. As such, the return you can expect from this stock, adjusted for the risk that it will go down (like so many "excellent" stocks) is no different than any other well-understood investment. We diversify to protect ourselves against risk. If ten stocks each have a five percent chance of collapsing like Enron, the chance that all of them will collapse becomes vanishingly small. What price do we pay for diversification? In terms of expected rate of return, none. What we "lose" is the chance that we'll be the lucky guy who hits a home run. Say that each of the same ten stocks has a five percent chance of increasing in value ten fold. The chance that the entire portfolio will behave that way is also vanishingly small. Of course there's more to it than just owning different stocks. The trick is to own stocks that can be expected to behave differently from each other. If you owned ten broadband related stocks over the past several years, it would not have provided you with much protection. They all collapsed, though in varying degrees. An inexpensive and simple way to diversify is to buy broadly based index funds with an eye to those with the lowest expense ratios, and to include some diversified fixed income investments in your portfolio. As I explained in answer to the first question, the taxpayer pays to encourage savings in tax-qualified vehicles. The social policy behind this subsidy is to encourage prudent saving for retirement so that people can have a safe and independent old age. There is no public interest in having people take needless risks with this money so that some will wind up wealthy, and others will wind up impoverished because they placed their bet on a Blue Chip like Enron which turned out to be a dog. James Delaplane responds: Without knowing the exact proportion of your retirement funds that are invested in the single Blue Chip company, it is hard to say whether your retirement portfolio should be more diversified. But certainly most financial advisers would recommend that your retirement portfolio be diversified among a number of different individual stocks as well as stock and bond mutual funds. The precise diversification strategy you should pursue depends upon a number of factors that are personal to your situation. Factors such as your age, your target retirement date, your tolerance for risk, your coverage by a pension plan (or lack thereof), the amount of your personal savings, your spouse's pension and savings status, and whether you own your own home are all relevant to what specific diversification strategy you should take. It is precisely because a proper diversification strategy will differ so much depending on these individual factors that we at the American Benefits Council oppose government attempts to prohibit certain investments in retirement accounts. For example, while a 20 percent cap on the amount of a 401(k) plan that could be held in a company stock might be an appropriate level for one individual, it will be wrong for many others. Take, for example, a 50-year old worker who just joined her employer a year ago. She has a $200,000 401(k) balance from her former company, which is invested in broadly diversified mutual funds. Her husband has a good pension and the couple owns their own home. If this worker has a 401(k) balance with the new company of $5,000 and wants to invest $2,500 of that amount in company stock, that is perfectly appropriate because it represents a small share of the couple's overall retirement portfolio. Why should the government tell this worker that she cannot do this? Most individual employees with whom I have visited have opposed the idea of the government restricting their investment decisions. We at the American Benefits Council believe the proper approach is to give employees the information, education, and professional advice they need to wisely make their 401(k) investment decisions.