The Worst Stock You Could Ever Buy

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Making smart choices with your retirement savings can make or break your finances over the course of your career. But with stock market volatility on the rise and the future looking more uncertain than ever, investors are increasingly making mistakes based on short-term thinking rather than long-term planning.

One trend has to do with workers' 401(k) retirement accounts. As you'd expect, some investors are moving to the sidelines given the recent declines in stocks. But others are making more aggressive moves to narrow the focus of their retirement investing -- moves that could lead them in exactly the wrong direction.

Going to the extremes
Whenever risk levels in the financial markets rise, it's common to see ordinary investors retreat to safe-haven investments like cash and bonds. Their low interest rates may not give you strong returns, but their perceived safety keeps you from staying awake at night worrying about your portfolio.

According to a recent report from Aon Hewitt, that's exactly what happened when the stock market fell sharply during August and September. Investors didn't move a huge amount of money out of stock mutual funds inside their 401(k)s, but what they did move largely found its way into bond funds.

But what's surprising is that many investors went the opposite direction on the risk spectrum. In September, more than a third of the money that workers took out of stock funds went into shares of their employer's stock. In other words, plan participants traded diversified exposure to the broad market for concentrated exposure to a single company.

Who's making the moves?
Obviously, that doesn't sound like a risk-reduction strategy. Not only does owning a substantial position in your employer's stock leave you vulnerable to a huge drop if something happens to the company, it also concentrates your overall financial risk. After all, you already get your salary from your employer; if the worst happens, you could find yourself both without a job and with your retirement savings severely slashed.

But even though the overall trend has been toward owning less company stock, there are still pockets of big ownership within 401(k) plans. For instance, the tracking company BrightScope maintains records of how much workers own in company stock in 401(k)s, and among those with high ownership levels of employer stock are Chesapeake Energy (NYS: CHK) at 48%, Procter & Gamble (NYS: PG) at 42%, and  General Electric (NYS: GE) at 41%.

The problem even exists among companies whose employees should know better. Financial companies including Bank of New York Mellon (NYS: BK) , US Bancorp (NYS: USB) , and Bank of America (NYS: BAC) all had levels of employer-stock ownership above the median, according to the Plan Sponsor Council of America. That's true despite their workers knowing just how hard-hit their stocks could get in a renewed financial crisis.

Of course, the one thing that these figures can't show is how 401(k)s incorporate into workers' overall financial plans. If your 401(k) represents a relatively small piece of your overall finances, then having what looks like a huge concentration of employer stock may actually represent only a few percent of your overall holdings. That may make a decision to own employer stock a lot more prudent.

The better move
Moreover, lately, many employers have put restrictions on how much workers can invest in company stock. With companies like Ford (NYS: F) having faced lawsuits from workers over losses in company stock within 401(k) plans, employers are eager to avoid any liability.

But as uncomfortable as it is to suffer through down periods in the market, owning diversified stock funds within your 401(k) often turns out to be the best choice you have. With the need for substantial growth over the course of your career, trying to guess when the market's going to drop can leave you far short of your long-range financial goals.

Avoiding pitfalls like holding too much employer stock is just one key to a successful retirement saving plan. Learn more about the right stuff for your retirement in the Fool's newest free special report, "The Shocking Can't-Miss Truth About Your Retirement."

At the time this article was published Fool contributor Dan Caplinger dodged a bullet owning shares of his former employer's stock. You can follow him on Twitter here. He doesn't own shares of the stocks mentioned in this article. The Motley Fool owns shares of Bank of America and Ford. Motley Fool newsletter services have recommended buying shares of Chesapeake Energy and Ford. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy is simply the best.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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