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By Holly SwanExecutive Director, Advisor Institute

If you have clients working for large public companies, they may have a source of risk that lurks below the water line, like most of an iceberg. That risk is employer stock inside an employer-sponsored qualified plan, such as a 401(k) plan, and it can become a client's largest exposure to employer stock. Whereas the stock you see "above the waterline"—equity awards—may be much smaller. 

Many advisors tend to overlook this "below-the-waterline" risk in retirement plans because:

  • They are not the plan administrators.
  • They do not provide advice on assets they don't manage.
  • There can be tax advantages to holding employer stock inside a 401(k).

However, the concentration risk is real—especially for employees who have spent most of their careers with a single employer. How can you see below the waterline? Try asking your clients these questions and watch your visibility improve.

  1. "Do you participate in an employer-sponsored qualified retirement plan?"
  2. "What percentage of your current allocation in that plan consists of your employer's stock?"
  3. "If your employer stock were replaced by cash overnight, would you buy back all of the employer stock you had before?"
  4. "If you left your employer tomorrow, would you have a different opinion of that stock exposure?"

Your clients' answers can tell you a lot about their exposures and attachments to employer stock—exactly what you need to know if you want to introduce the concept of diversification.

Questions 1 and 2 help illustrate the extent of their concentrations, while questions 3 and 4 challenge their emotional attachments. It is important to note the questions do not challenge the investment outlook for the employer. Instead, they help to expose the size and nature of a client's exposure—the mass of the iceberg below the surface. When discussing how to minimize this concentration risk be sure to be mindful of the net unrealized appreciation rules that apply to employer stock held inside a 401(k) and suggest that they seek guidance from their tax counsel before selling employer stock inside the 401(k).

Bottom line: To help your clients manage concentration risk, be sure to look above and below the waterline to see just how much of the proverbial iceberg rests below its surface.

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