You recently graduated from college and accepted a job at M&D, Inc. The HR manag

Question

You recently graduated from college and accepted a job at M&D, Inc. The HR manager informs you about the company’s new 401 (k) plan. A 401 (k) plan is a tax deferred retirement plan, meaning that no current taxes are paid on the money deposited. For example, assuming a $30,000 salary per year and a $1,500 contribution to your 401 (k), the taxable income is reduced to $28,500. No taxes will be due on any capital gains or plan income while you are invested in the plan, but you will pay taxes when you withdraw the money at retirement. You can contribute up to 15% of your salary to the plan and the company has a 5% match program. This means that the company will match your contribution dollar for dollar up to 5% of your salary, but you must contribute to get the match. The 401(k) plan has several options for investments, most of which are mutual funds. When you purchase shares in a mutual fund, you are actually purchasing partial ownership of the fund’s assets, similar to purchasing shares of stock in a company. The return of the fund is the weighted average of the return of the assets owned by the fund, minus any expenses, with the largest expense being the management fee paid to managers to manage the fund. The retirement investments options offered by M&D are as follows:

a) Company stock. (stock in M&D) The company is currently privately held and its stock is appraised annually. You will be purchasing the stock at a 20% discount from the appraised value. The company is expected to go public in 3 to 5 years. If you need to sell the stock before the company becomes public, the company would buy it back at the then-current appraised value.

b) Vanguard S&P500 Index Fund. This mutual fund tracks the S&P 500 index, so its return is approximately the return on the S&P 500 minus the expenses. Vanguard charges expenses of 0.2% of assets per year

c) Vanguard Small Cap Fund. This fund primarily invests in small capitalization stocks. As such, the returns of the fund are more volatile. The fund charges 1.7% of assets in expenses per year.

d) Vanguard Large Cap Fund. This fund invests primarily in large capitalization stocks of the US companies. The fund manager has outperformed the market in 7 of the last ten years. The fund charges 1.5% in expenses.

Questions:

1. What advantages/disadvantages do the mutual funds offer compared to company stock for your retirement investing?

2. The company matches your contributions up to 5% of your salary. What return on your investment does this represent? What does your answer suggest about matching programs?

3. What are the advantages / disadvantages of choosing Vanguard Large Cap Fund over the Vanguard S&P 500 Index Fund?

4. Why would you consider investing in the Vanguard Small Cap Fund? How do the expenses charged by the fund affect your decision to invest in the fund?

Explanation / Answer

Answer-1

Mutual funds offer several advantages over direct investing in individual stocks or securities, such as the follows:
1) Using mutual funds can help you diversify your portfolio with minimum investment.
2) Mutual funds are managed and supervised by professionally qualified fund managers who are in a better position to understand the markets than individual investor.
3) Ease of Investing. You can conduct transactions by mail, phone, or over the Internet.
4) Ability to participate in investments typically only available for larger investors.
5) Liquidity advantage. Mutual fund shares are liquid and can be bought or sold on any business day.
6) Government oversight. Mutual funds are subject to government regulations.
7) Convenience and flexibility.
8) Low cost investment.

The disadvantages of mutual funds include:
1) Loss of control: Fund managers make all the decisions about which securities to purchase and sell and when to do so.
2) Dilution: Although diversification reduces the risk involved, it can also be a disadvantage due to dilution.
3) Mutual funds tend to have high sales charges.

Risk is the main factor. Mutual funds are relatively less risky and your employers stock it can be even more risky, because if they fail, and you lose your job you are out a job and your retirement.

Answer-2

He makes Salary $30,000 and has elected to contribute $1500 of her annual salary to her 401(k) plan.

Company will match 5 % of her contributions

Each year, he would contribute $1500 (5% of her salary) to her 401(k) plan and company would contribute $1,500 (5% of her salary) to her 401(k) plan

The total yearly contribution made to his retirement account would be $3000

Even if he elected to contribute 15% of her salary to her 401(k) plan, which would be $4500, her company still would only contribute 5% because they stipulated that their match is capped at 5% of employee salary.

Answer-3

Advantages / disadvantages of choosing Vanguard Large Cap Fund over S&P500 Index Fund

Advantage : Large cap fund cover various industries shares , experience fund manager

Disadvantage : high fund expenses

Answer-4

Yes , we consider to investing in Venguard Small Cap fund as Mid- and small-cap companies are the ones that will become large caps in the future and therefore they schemes have the potential to generate higher return.

While investment into mid- and small-cap schemes is not something that one should be averse to, experts feel that even within an asset class such as equity mutual funds, investors should have proper asset allocation across various categories and it is not a good decision to park all your investment into a more risky category.

The consensus among investment advisors is that only up to 30 per cent of equity mutual fund investment should be routed into mid- and small-cap schemes. There is a view that if the money is going into mid- and small-cap schemes it should be through systematic investment plans.

Every mutual fund has certain costs associated with it. In reviewing funds to include in your portfolio, consider these costs as part of your decision-making process:

Management Expense Ratio (MER)
The MER is the total of the management fee, operating expenses (or administration fee) and GST/HST charged to a fund each year, expressed as a percentage of a fund’s average net assets for that year. All mutual funds have an MER.

The returns you earn as an investor reflect performance data that is reported after the fund’s MER is deducted. For example, if your fund’s investments gained 9% last year and the fund’s MER was 2%, the reported return would be 7% for that time period.

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