Q. I’m 67 and about to retire. I don’t have all of the $2 million I have accumulated in my company stock but 60% is. I need to draw about $50,000 a year to do what I want and supplement my Social Security and pension. I never paid it much attention, but it started doing well so I kept buying more. I think it will continue to do well, so I am hesitant to sell it. What do you think I should do? — Sid in Suntree
A. Sid, first, congratulations on building your savings to that size. That’s great!
For most people, the primary retirement goal is to amass a big enough nest egg that they can maintain an acceptable standard of living for the rest of their life after they stop working. There are hundreds of studies about how much money that is. I do not know of any that would say you do not have enough even after accounting for taxes and inflation given you need just $50,000 from $2 million. So, if lifetime cash flow is your goal as well, you have the proverbial bird in your hand right now.
It is important to note, all these studies assume a broadly diversified portfolio. Holding $1.2 million in the stock of one company is not broadly diversified. If the stock tanks, you can be in a very different financial condition. It doesn’t matter why the stock price drops or that you had no way of knowing the drop was coming. If it comes, it will hurt.
There are two factors that need consideration when it comes to investment decisions: the probabilities and the possible outcomes. Most people dramatically misestimate one or both when it comes to company stock.
Your statement about the stock doing well of late may be true but that doesn’t mean the probability of the stock continuing to do well is high. One of the consistent observations of studies that look at such issues is that employees who own stocks that have gone up place a higher probability on future gains than employees who own the stock of an employer that has not produced strong gains. Behavioral finance professors call that “recency bias.”
Further, there is a strong correlation between the performance of a stock and the percentage of that company’s employees that own shares. The better the stock has done, the more employees will own some shares.
It makes sense that if a stock does well, more people will want to own it. Academics would say chasing what has been hot and expecting it to continue is a sign of familiarity bias and overconfidence. However, studies show that most individual stocks do not produce returns in excess of T-bills.
That surprises a lot of people because the market overall has done well over time. The market has done well because a very small number of stocks performed exceptionally well lifting the aggregate result (Bessembinder 2018, Heaton, Polson, & Witte, 2017).
You are suggesting that your company has better odds than most stocks. You may even be thinking it will be one of those few that lift the overall market. Odds are you are wrong about that but neither I nor anyone else could guarantee it. So, let’s forget about the odds for a moment and think about the consequences. Here’s an extreme example that illustrates that both probability and possible outcomes matter.
Russian roulette is a game that gives you an 83.3% (5 out of 6) chance of success but I’m confident you would never play it because the penalty for losing — death! — is too extreme. The penalty for betting so much on this one stock isn’t death of course but it could be a much lower standard of living for the rest of your life.
I don’t know what company we are talking about, so I don’t have any history with it, I don’t know the company’s “story” or hear buzz about it around the office. I also have no emotional attachment to it, so it is easier for me to tune out the noise and be more objective.
My recommendation is to consider dramatically reducing your holding in the company and all but eliminate the risk of a retirement that is less than you wanted. You have “enough.” Why risk it?
Dan Moisand, CFP®, is a past national president of the Financial Planning Association and has been featured as one of America’s top independent fee-only financial planners by at least 10 national financial planning publications. For more info, visit www.moisandfitzgerald.com or call him at 321-253-5400, ext. 101.
Originally published on FloridaToday. Read the original article here.