Case 3
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?
References
Brigham, E. F., & Houston, J. F.
(2015). Fundamentals of financial management.
(Brigham & Houston, 2015, p. 303).
