A typical employer investment program will allow you to save a portion of your after-tax regular paycheck into a special fund. This is a great strategy as it allows you to pay yourself first before any other bills are paid. I applaud this type of program! However, doing this doesn't make investing in your employer a great deal.
The second step of the investment program that provides investing in your employer will vary somewhat from employer to employer. Typically, the employer selects a period of time of either 3-months or 6-months. The value of the stock to be purchased is determined by either the lowest of either the start or the end of the period. In some cases, I have heard that the average of the start and end are used. The employer may elect to give a discount from that price, as well. The discount can be 10% or 15%.
This can make investing in your employer seem like a great deal. You have an automatic savings program that allows you to buy at the best price over a period of time. The employer may have even subsidized the investment which further increases your profit.
Unfortunately, this is where the good habits tend to stop. I have seen people that use this type of program develop an effective portfolio where 20-40% of their portfolio is in their employer. This is way too high for any single company and even worse for your employer. Remember, you are already investing your time every week in that company. They are providing 100% of your income.
Think of your paycheck as a dividend check based on your labor. You are investing your daily work time into that company, and in return you are receiving a dividend check for that effort. Under that scenario, your employer already plays an extremely large portion of your portfolio. By investing in the company as well, you are committing an outlandish portion of your net worth to one investment.
So what is the solution to investing in your employer?
If your employer is subsidizing the program by discounting the purchase by at least 5%, you should participate. Investing in your employer for the short term will then make good economic sense. However, once the investment in your employer reaches 5% of your portfolio, you need to start liquidating the stock. You could do this on a LIFO (Last In First Out) basis and immediately sell the stock you just bought at a discount. You could also do it on a FIFO (First In First Out) basis and sell the shares you first accumulated in the program.
Avoid investing too much in the stock of any company that you currently work for. You are essentially doubling your risk. Should something go wrong with the company, you are looking at losing both your investment and paycheck at the same time. Although, if employee shares can be purchased at discount, it might be a good bargain and worth purchasing. While it is fine to support your company by purchasing stock, you do not want your portfolio to consist mainly of that one investment. When you put all your faith in one stock and it does not perform at the level you expected, you can end up losing all or most of your investment as the price of the stock falls or if a company goes out of business. This is even more painful if you lose your job, as well.
Image courtesy of smarnad at FreeDigitalPhotos.net