Mind on My Money

How to invest wisely

John Nofsinger is an associate professor of finance at Washington State University and a speaker, writer, and scholar on behavioral finance. See full bio

July 4, 2008, Behavioral Economics

401(k) Investing: Do We Learn From Others’ Mistakes?

Have people learned from the investing experience of Enron employees?

asset allocation Employees invest too much of their 401(k) pension assets into their employer's stock. Much of this problem can be attributed to a belief (through a familiarity bias) that their company stock is a "good" investment (high return and low risk, see blog posting).

Concentrating much of your portfolio in one investment (especially the company you work for!) is a dangerous strategy. If the company has financial difficulty, you could lose your job and your retirement money. If fact, we have seen this happen several times.

Consider a firm like Enron. By the end of 2000, it had been on the cover of Fortune and listed by them as one of the most respected companies. Its stock had performed quite well. Enron employees may have believed that its stock was one of the safest investments they could make. Indeed, 62% of the assets in the 401(k) plan were invested in Enron stock. Unfortunately, one year later the stock was worthless. There were literally tens of thousands of print and broadcast stories about Enron's collapse. Many of them were about the employees that owned Enron stock. Remember the 60+ year old employee who was 100 percent invested in the company stock? That person was facing no job and no retirement funds, ouch! Soon followed similar stories from the bankruptcies of Global Crossing and WorldCom.

Did this media attention cause us to run to our human resources department to fill out the paperwork to sell our employer's stock and diversify into other investments? James Choi, David Laibson, and Brigitte Madrian examine the pension plan asset allocation of employees in a large sample of firms that collectively employ 1.5 million people. The figure below shows the portion of the employer's stock that make up the total allocation to equity investments and the portion that make up the total money invested. For example, from 1997 to 2000, between 35% and 50% of the total equity investment was invested in the employer's stock. Consider the time periods that we heard about the Enron and Global Crossing debacles. Does it appear that employees significantly reduced their ownership of the company stock?

ownership after Enron

No, it appears that people did not reduce their allocation to the company stock. The company stock allocation of total equities stayed in the range of 40% to 45% following the media attention, which is well within the pre-Enron range. We really didn't learn from the well-publicized mistakes of others.

(See James J. Choi, David Laibson and Brigitte C. Madrian, 2005, "Are Empowerment and Education Enough? Underdiversification in 401(k) Plans," Brookings Papers on Economic Activity, 2, 151-198)