Diversify to Avoid Enron Employees' Fate!

Dear Readers,
Like most of you, I have been following the unfolding Enron scandal/soap opera with a mixture of disbelief, disgust and morbid fascination.

I cannot tell you how it will all conclude, but I am very confident that it will be dealt with swiftly (for Congress) for the simple reason that the issues transcend Enron, its employees and its accounting firm Arthur Anderson. In fact, they threaten the very foundation on which our entire financial system rests: Trust.

If you can't trust that corporate executives are operating their company according to open and honest and accepted standards, and if you can't rely on one of the largest accounting firms in the world to keep tabs on them, and if you can't believe what your bosses tell you about the financial health and stability of the company you work for, then Enron is not the only company in trouble.

And we cannot have American investors and American workers wondering, "Who's the next Enron?"

The issues brought to the fore by Enron — not the barbaric terrorist attacks on the World Trade Center — are the biggest threat our financial system faces today. For if you cannot trust, you do not invest. Banks do not make loans. Consumers do not buy homes, cars, vacations and all the other goods and services that fuel two-thirds of this economy. If you
doubt the truth and the strength of the institutions which make up our economy, you stuff your money in your mattress. And pray.

So know this for certain: The problems at Enron, and the larger problems they have brought to light, WILL be resolved in short order. This is no different from the financial crisis we faced at the beginning of the 1990s when we learned that thousands of supposedly conservative savings and loans had made speculative real estate loans that, because of a collapse in real estate values, were largely worthless. We're talking hundreds of billions of dollars here, folks.

What the federal government did then was remarkable. Seemingly overnight, Congress created a new, temporary entity to resolve the situation: the "Resolution Trust Corporation." And it gave the RTC broad, powers to literally take over insolvent S&Ls, sell off whatever assets they had, and shut them down. You and I paid for this via higher taxes and lower interest rates on our money. The banking industry also had to share the cost through higher fees paid to the federal government. But it was temporary. And, amazingly, in just a couple of years, faith was restored to our banking system.

Compare this to the mess Japan has been in for more than a decade. Like our S&Ls, Japanese banks are sitting on billions — perhaps trillions — of dollars in worthless loans, often made on soured real estate deals. For a number of complex reasons — political, cultural, social, economic — the Japanese government cannot bring itself to deal with the situation.

Instead of admitting there is a serious problem and taking whatever measures are necessary to fix things, due to the cozy relationship between politicians and corporate Japan, the government continues to apply Band-Aids. This is a major reason Japan has been mired in a depression for more than ten years.

We can "tsk-tsk" and speculate about whether politicians granted Enron special favors in exchange for campaign contributions, but our system — flawed though it may be — is squeaky clean compared to what has gone on in Japan for centuries. The fact is, under current law, US politicians did nothing wrong in accepting campaign money from Enron and its executives.

It is their actions in connection with the disclosure of Enron's problems that we should judge them by. Right now, both Republicans and Democrats are elbowing each other aside to see who can deliver the juiciest sound bite and land up on the evening news. But make no mistake: grand-standing aside, they understand how serious the situation is and the consequences not just for Enron, but our entire economy.

On a personal level, you might be wondering whether you could be "Enron-ed" by your own employer.

Is your retirement account in jeopardy? Other firms, such as Global Crossings, are now under investigation for "creative " accounting schemes. Who knows who's next?

I know this is going to sound harsh, but to a certain extent, Enron employees who now claim to have "lost" hundreds of thousands of dollars of retirement funds did it to themselves. Don't get me wrong — in my mind Enron definitely shares culpability in this. But so do its employees. Because instead of diversifying their 401(k) money into other investments, they loaded up on even more Enron stock, on top of what the company was contributing to their accounts.

This is more common than you think. Federal law prohibits most retirement plans from investing more than 10% of their assets in company stock. The exceptions are profit-sharing, stock bonus, Employee Stock Ownership (ESOP) and thrift plans.

The Employee Benefit Research Institute, a non-profit research organization, has studied these plans. EBRI found that when an employer makes its contributions to the company retirement plan in corporate stock, the total percentage allocated to company stock is higher than in plans where the company's contribution is made in cash. In fact, it's significantly higher: 33% versus 22%. In other words, employees compound their concentration in company stock by buying more shares with their own contributions!

In addition, if a company's contribution is in stock, EBRI found that employees tend to have a higher percentage of their retirement dollars allocated to equities in general.

And while you could argue that some Enron employees didn't realize the risk they were taking, that they believed Ken Lay's happy picture of future earnings, the fact is, two years ago you could not have convinced most of them to sell even a portion of the Enron stock in their retirement plans and invest the money elsewhere — bonds, for instance. After all, Enron shares had had a spectacular rise. Most employees probably thought the bigger risk was losing out on future increases in the stock price. A financial advisor who suggested otherwise would have been laughed at — or fired.

Fact is, in January 2001, when Enron stock was around $80 a share, it represented an incredible sixty-two percent of the assets in the company retirement plan! That didn't all come from Enron. A huge portion came from Enron employees loading up on more stock themselves. By comparison, at the peak, Lucent shares made up 17% of that company's 401(k) assets. The average amount of retirement plan money invested in company stock during the late 1990s was 19%. No matter how many laws Congress passes, they can't protect us from our own greed.

So what should you do, especially if your company contributes to your plan via its own stock? Diversify! Don't compound the situation by buying more stock. And diversify away from U.S. equities. Consider bonds and foreign stocks for a portion of your money.

If there are limited investment choices in your plan, you've got to think of your retirement money as part of your total portfolio. If you can't get adequate diversification in your plan, then you've got to diversify with the investments you have outside your plan.

"But," you say, "I love my company and look at the historical trend in its stock price, and I just know the folks running this company are honest business people." Right. Just keep in mind that by loading up on your employer's stock, your: 1. Current income; 2. Future income; 3. Home value (have you seen what's happened to Houston real estate prices?) are all dependent upon the continued financial strength of your company.

If ten percent is the maximum amount of company stock the government allows pension plans to own, then use that as your personal guideline. Any more represents too big a risk for me.

Gail

If you have a question for Gail Buckner and the Your $ Matters column, send them to moneymatters@foxnews.com  along with your name and phone number.

The views expressed in this article are those of Ms. Buckner or the individual commentator, and do not necessarily reflect the views of Putnam Investments Inc. or any of its affiliates. You should consult your own financial adviser for advice regarding your particular financial circumstances. This article is for information only and is not an offer of the sale of any mutual fund or other investment.