9 Tips for Railroad Stock DiversificationRetirement Financial Planning Investing
A big challenge as I grow Highball Advisors is counseling prospects and clients that owning too much railroad stock is something that should be avoided. Hopefully, stories of employees at Enron, Lehman Brothers, General Electric, etc.. have shaken them to get their attention.
The a fair amount of employees of publicly traded railroads have their personal wealth highly concentrated in their railroads' stock. This could be due to a combination of factors such as stock option grants, stock purchase, restricted stock units, performance share units, and stock in 401k plans. Let's evaluate the the risk a railroader takes and decide whether and how to diversify.
1. Ownership Mindset
Your railroad wants you to think and work like an owner, with your equity compensation acting both as motivator and reward. Various forms of stock pay align worker and shareholder financial interests. In an effort to create this ownership culture, railroads make it easy for their employees to own company stock or rely on it for personal wealth. They award stock option grants and restricted stock, along with having ESPPs that offer a discount. Additionally, many railroads make company stock an investment choice in their 401(k) plans.
2. All I Know Is My Railroad
These benefit plans are a good deal that have helped many railroaders build substantial personal wealth and reach their financial goals. You may envy and hope to emulate the former railroaders who were successful on their company stock. It’s an axiom of investing to buy stock in companies and industries you know and believe in and then hold for the long term. However, employee stock investors who have a strong emotional commitment to their railroad are following this maxim to the extreme.
3. Nothing Is Free
With large potential gains come risks you must understand and accept. A large, single-stock position in your railroad will likely cause improper diversification by throwing off your asset allocation (i.e. putting too many eggs in one basket).
Asset allocation generally determines most of your portfolio performance. If your railroad stock underperforms the market, time magnifies the impact. A recent study examined the four-year performance of all companies that were members of the S&P 500 at some point between 1997 and 2012. Specifically, it looked at the four-year performance of each company, starting on its date of inclusion in the index, or an anniversary of its inclusion, so long as it remained a member of the index. The historical figures show that the median company underperformed the index by roughly 2.5% over one year, 5% over two years, and by over 10% over four years.
4. Understand How Much Railroad Stock You Own
You probably know your weight, cholesterol level, blood pressure, and family health history. It's time you understand the same type of factors that impact your financial health. Below is a simple chart you can use to summarize the percentage of your net worth (excluding real estate and other illiquid assets, such as collectibles) that is currently in railroad stock and options
|Percentage of Wealth in Railroad Stock|
|Wealth Source||Total $ Amount||% of in Railroad Stock|
|Taxable Accts (ESPP,vested RSUs, vested PSUs, share from option exercise)|
|In-the-Money vested options, plus Taxable Accounts|
|Other retirement savings (e.g. IRA, plus 401k(include spouse)|
5. Impact of Railroad Stock Price Swings
A simple mathematical correlation explains the effect of price swings. Multiply a typical percentage increase or decrease in your railroad stock price by the percentage of your personal wealth in company stock, assuming there are no other changes in your other investments. For example, if the stock price moves 20% and railroad stock is 80% of your wealth, it changes by 16% (.80 x .20 = .16 x 100 = 16%). Below is a chart showing the correlation between railroad stock ownership percentage and a 20% change in company stock price.
|Relationship Between Railroad Stock Ownership and Price Changes|
|Ownership %||% Price Change||% Personal Wealth Change|
6. See The Forest Through the Trees
You could get more sophisticated by looking at your railroad stock history of percentage increases and decreases (i.e. volatility), and also by analyzing how this compares to the riskiness of alternative investments. However, given the uncertainty in the stock markets and the drastic changes in many railroads' prices in the last few years, most railroads' historical performances will not prove to be a useful predictor of future behavior. You can complete your financial picture by considering your other investments in similar industries, whether they are mutual funds or individual stocks, because industry sectors can move in unison.
7.You Have to Sleep at Night
Ultimately, you need to decide what level of risk helps you reach your financial goals, and must understand the upside and downside of the risks you take. Most of us tend to be more risk-averse than we realize, which we often realize too late.
At some point with your railroad stock, too much of a good thing can cause you to worry, lose sleep, and become too focused and frustrated about its performance. For some people, 20% of their net worth in company stock is the magic number; for others, it is larger or smaller.
Financial planning tools are available to help you pin down your own tolerance for risk and develop an "ideal" portfolio allocation. I have come to the conclusion that even the most experienced investors believe that their individual situations are unique. They will want to adjust the recommendations of an impersonal planning tool to fit their own lifestyles, market predictions, and circumstances.
8. Diversify in retirement accounts
Should your railroad stock represent too large a portion of your retirement savings for your risk tolerance, examine ways to reduce overconcentration, which can quickly grow in years when your railroad's stock performs very well. If your railroad makes matching contributions in stock, and especially if the plan restricts you from moving your employer-match portion, the accumulation can sneak up on you.
Employees of some of America's best-known companies have experienced some not-so-well-known, but nevertheless spectacular, stock-price collapses. Well-publicized debacles like Enron are familiar. Less well remembered are the declines of household names like Sears or Bristol-Myers Squibb. Even the employees of financial companies like Lehman Brothers, who might have been expected to know better, have made the mistake of betting their entire retirement future on the company stock.
If you face this high-risk circumstance, diversify your contributions in as orderly a fashion as you can, consistent with your company's rules. Make sure to allocate your retirement-plan portfolio across multiple sections of market segments available in your plan (e.g. growth, value, large cap, small cap, international, and bonds).
9. Stay On Top of It
Your railroad wants you to see its stock plans as long-term wealth builders and to share in the railroad's financial success that you help create. Employee stock ownership and financial sanity can co-exist as goals. By doing a regular financial check-up, finding your comfort zone for your ownership percentages, analyzing your company's financial results, and rebalancing to diversify your portfolio, you can best maximize the value of your stock-based employee benefits.
Start Boarding for Railroad Retirement
Photo by Frank Orona
Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. Highball Advisors encourages you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Highball Advisors, and all rights are reserved.from Highball Advisors, and all rights are reserved.