Most railroad company retirement plans allow for railroaders to own the company stock inside their 401k. They may even be able to purchase the railroad’s stock at a discount to the market price. Also some railroaders are compensated with stock options that convert into shares of the railroad at a later date if the options are exercised. With the potential to have a significant amount of your retirement portfolio concentrated in railroad stock, what is the prudent amount to own?
If you worked for Worldcom, Lehman Brothers, Enron, Kodak, etc. then your answer would be 0%. Perhaps General Electric (GE) stock. It has gone down 27% per year for the last three years. So If you had any of those companies that disappeared then it’s sadly off to Social Security for your retirement life. A crushing reality for many hard working people who thought they would be taken care of in retirement with their company stock. Even a significant drop of 50% or more could force a retiree to continue working for another 5 to 10 years.
However, Class 1 railroads stock have been on a tremendous run for the last 10 years with Total Returns upwards of 15% per year. But as we have seen here in March of 2020 the drop can come quickly and with great financial pain. There is currently great unease in the railroad industry. Revenues are dropping. Major labor restructuring. Now throw in a steep plunge in oil prices and a worldwide pandemic, it all creates an uncertainty for the short-term economic fundamentals of railroads.
When you examine your retirement portfolio, it should start with your investment goals and risk tolerance. Let’s put your investment goals to the side for now. When we talk about risk, it is the degree of variability in investment returns that you are willing to withstand. Or simply put how much pain can you withstand before you panic and sell at the wrong time. Not every investor has the same comfort with risk. There is also no right answer to how much risk an individual can tolerate. The reality is that you need to take some measure of risk to have your money grow. Otherwise it will be eaten up every year by rising inflation. Let’s explore the risk part of the retirement investment equation further.
At Highball Advisors, we use a risk tolerance platform called Riskalyze. Through a series of questions, it will create a Risk Number for an individual. The Risk Number is represented by a Speed Limit sign. This basically answers the question at what speed are you comfortable driving your investments. There are five widely accepted Risk Tolerance Risk Categories for investors:
|This investor isn’t willing to tolerate "noticeable downside market fluctuations," and is willing to forego most all significant upside potential, relative to the markets, to achieve this goal.|
|Moderate Conservative||If a worried investor can tolerate a little more risk than the Conservative investor, but still is adverse to large short-term downside fluctuations, and wants a little more return|
|Moderate||These investors want good returns, and know they're taking some risk to get them. They should expect returns similar to a basket of similarly weighted market indices. Their portfolio should go up less than the markets as a whole, but should also go down less when markets go down.|
|They are taking on more downside risk than the markets, but expect to be substantially ahead of the game when markets go up. Fixed income positions are minimized and risky asset classes are fully utilized. Most of the bond and international stock mutual funds in this portfolio are aggressively-managed.|
|These investors want to substantially outperform the markets and (should) know they are exposed to much more risk than the markets. They could easily lose up to 40% of their portfolio value in a few months, and it may take years, if ever, to recoup these losses.|
Once your risk tolerance is completely understood a competent financial advisor should be able to build a diversified portfolio of investments that matches your risk profile. For example, let’s assume an individual is a Moderate with a Risk Number of 54 then what kind of a portfolio can that individual expect:
% Percent of Portfolio
|iShares S&P 500||40%|
|iShares MSCI Total Stock Index||22%|
|iShares US Treasury Bond||15%|
|iShares Investment Grade Debt||13%|
|iShares S&P Small Cap||10%|
Riskalyze with their proprietary algorithm projects the above portfolio with 95% certainty that over the next six months the investor will be between up 16.41% to down 11.15%. Even though the gap is wide over time the portfolio should meet the investors goals if the sequence of returns stays within those return goalposts.
As you can see not only is the individual assigned a Risk Number but the investments themselves are assigned Risk Numbers. It is imperative to build a diversified portfolio of investments that match the investors risk tolerance and their goals.
So now let’s look at a railroader who has their entire retirement portfolio completely in their Class 1 Railroad Stock:
|Class 1 Railroad|
95% Probability (6 months)
|CSX||-26.18% to +42.78%|
|Union Pacific||-20.96% to +38.13%|
|Norfolk Southern||-25.11% to +39.31%|
|Canadian National||-19.86% to +34.31%|
|Canadian Pacific||-25.92% to 42.43%|
|Kansas City Southern||-31.32% to 46.76%|
As you can see a railroader might have a profile of a Moderate(54) investor on the Risk scale but is invested almost 15 points above an Aggressive(76) investor on the Risk Number scale. Most railroaders wouldn’t believe they were invested like this because after all it is the railroad. It has been around for over a hundred years and has been a bulwark in the growth of the US economy. While the railroading industry isn’t going anywhere soon each individual company has their own risks and challenges. I am sure the shareholders of other Class 1s that disappeared throughout the 20th century had the same thought. Circumstances that are seen and unseen in the economic cycle come up sometimes that are sometimes beyond the control of an individual railroad. It is these circumstances occurring and taking hold that can have a damaging effect on a railroader’s retirement portfolio.
How much of a railroad stock should a railroader own? A very good guideline would be no more than 10% of an overall retirement portfolio. Let’s look at a Moderate(54) diversified railroader’s portfolio with a 10% ownership of railroad stock:
|Instruments||% Percent of Portfolio||Risk Number|
|iShares S&P 500||35%|
|iShares MSCI Total Stock Index||19%|
|iShares US Treasury Bond||15%|
|iShares Investment Grade Debt||13%|
|iShares S&P Small Cap||9%|
|Class 1 Railroad Stock||10%|
Riskalyze projects the above portfolio with 95% certainty that over the next six months the investor performance will be between up 17.95% to down 12.02%. If you noticed the overall Risk number for the Railroads portfolio with the railroad stock is more in line with their risk tolerance. It is a well-diversified portfolio that isn’t tied to the performance of a single asset for returns. More importantly it still contains the correct amount of railroad stock.
Investing in railroads over the last 10 years has served railroaders extremely well until recently. Railroads over time should continue to perform well as the US economy picks up from this latest downturn. However, the latest downdraft in railroad stocks should make you revisit your need for a diversified retirement portfolio. If you would like your risk number for your railroad retirement portfolio to ensure you are invested correctly then CLICK HERE to get started.
Photo by Steve Hardin
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.