Retirement Planning: Don’t Invest Your Pension Primarily in Stock in This

Tempting though it may be, it’s an inherently risky move to invest most of your pension in the stock of the company for which you work. Here’s an explanation and an example to consider.

Don’t Keep the Bulk of Your Savings in Shares of the Company for Which You Work

There may be some comfort in investing in your own company. You may have pride in your employer and in your own work. You may feel that you would “know” if there were accounting irregularities or any weakness that threatens the company. You may know your company has a long history of steady growth.

It’s a risky choice.

Having Too Many $$ in the Same Company is Risky

Many people who work in large Canadian companies are offered opportunities to invest directly in the company for which they work. Often, there is a work savings plan that allows employees to buy shares in the company without paying a trading commission. If the company has a defined contribution pension plan, and most now do, one of the investment choices is to buy stock in the company, often with no commissions charged. Depending on the type of employee rewards program, they may be granted SARs or RSUs where the award’s payout is based on the value of the stock on a certain day or during a certain period.

Now imagine where else these employees are putting their savings and retirement money? Chances are good that at least some of it is going into a stock market ETF or mutual fund that includes their own company!

Having so much of your personal monetary worth tied to one company is inherently risky.

Learn from the Disastrous Impact of Nortel’s Collapse on Its Employees’ Pensions

A relative of mine was once employed by Nortel Networks. Like many Nortel employees much of his pension was invested in shares in Nortel. After all, at that time, Nortel was a mini-Bell. It was a secure, stable, growing Canadian corporation. It was even viewed as being largely conservative.

This relative worked for a splinter group in Nortel that the company decided one day to sell off. Part of the terms of sale was that certain of the key employees, including my relative, would move to the new business. Another condition of the sale was that the employees of the new company had to sell off any holdings in Nortel, specifically the ones in their pension plan.

That forced change in pension investments saved my relative thousands of dollars. Because just after he sold, Nortel collapsed.

For those of you too young or otherwise new to the Nortel saga, here’s a quick review. Nortel was a subsidiary of Bell. According to the CBCNews article Key dates in Nortel Networks’ history in 1977 it incorporated. In July 2000, during the dotcom bubble, Nortel’s stock hit a high of $124.50 per share. In 2002, the share price had plunged to 67 cents. It never really recovered. In June 2009 Nortel was delisted from the TSX.

Virtually none of the Nortel employees saw this coming. The collapse was caused, it appears, by two major problems. One, the price of the shares skyrocketed on the same euphoria that swept all high tech companies in the late 1990s, now called the dotcom bubble. The price shot way above the realistic value of the assets and the production of the company. Two, there may have been some actual illegal activity on the part of Nortel management. That is still being decided in the courts. Either way, when the dotcom implosion occurred, Nortel was caught up in the tidal wave and left battered and broken on the beach.

Many Nortel employees lost their jobs. Many of them then realized in horror that their personal savings plans and their retirement plans had been heavily invested directly in Nortel stock. They had lost virtually everything, through no fault of their own, in less than a year. No one saw it coming. No one person could have stopped it.

Don’t let it happen to you. Stay diversified. Doesn’t let most of your worth become invested in only one asset no matter how safe and secure it seems.

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Did you ever review your personal investments and realize with a shock that you are over-invested in one company or in one sector? Were you able to fix the problem in time? Please share your experiences with a comment.

Maximize your TFSA First

I believe most people should completely maximize their TFSA before they contribute to their personal RRSP.

The Exception: Work RRSPs Versus Personal RRSPs

There’s one exception. Some people’s work company pension plan is called a Group RRSP. Rather than having a defined contribution or defined benefit pension plan at work, they contribute money to an RRSP through their employer. The employer may also contribute to this same RRSP. I think employees should contribute to a Group RRSP if that is the only type of pension plan offered at work. In that case, the person should contribute to their work RRSP and then try to maximize their TFSA next, before starting a personal RRSP.

Maximizing a TFSA Doesn’t Require Much Money

As of January 2013, the most a person can contribute to a TFSA if he or she was 18 in 2009 is $25,500. (That does not include re-investing any money withdrawn from the TFSA in previous years.) Younger persons can contribute less.

Personally, I think everyone needs at least $25,000 in savings ready to help with regular living emergencies. If someone loses a job they may need savings to pay the bills until they find new work. Very few people find EI benefits are high enough to maintain their standard of living.

As of February 2014, the maximum a person can contribute if he or she was 18 in 2009 and lived in Canada the whole time since is $31 000. That’s still not much savings.

The savings are also intended to be a personal “reserve fund” for major expenses. For example, most homeowners will  need a new roof every 15-20 years. That means each year they should be saving some of the cost of that new roof. Many people also own cars. That means saving every year to be ready to buy one in 10-15 years when the current car wears out.

While saving for retirement is very important, I think it’s unnecessary to save in an RRSP when there is still room in a TFSA. Both allow investing in everything from cash and GICs, to bonds and bond funds, to shares and stock ETFs.

What Should I Do Once I Have Contributed my Maximum Allowable Amount to my TFSA?

Once a person’s TFSA is fully funded, it’s time to start an RRSP. How? I’ve written a series of posts on where to invest and in what, called Retirement Strategies. I invite you to read those articles and consider my approach.

Until you have more than $25,000 in savings I cannot personally see why you need to have an RRSP. (Disagree? Convince me with a quick comment!)

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Do you agree that people should top up their TFSA before they rev up their RRSP? Please share your experiences with a comment.