FIN 101 Lecture 8: Easy Investment Management At A Young Age- Purchasing Three or Four Stock Index Mutual Funds

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13 Aug 2020

School

Ball State University

Department

Finance

Course

FIN 101

Professor

Olga S Mc Atee

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Document Summary

Easy investment management at a young age: purchasing three or four stock index mutual. Investments are complicated, which is your biggest hurdle when investing because you might not know where to put your money. When you"re first starting out in this, make it as simple as you can. Otherwise, you"ll wait an extremely long time and miss a lot of opportunities to try and grow your money. Mutual funds are an investment vehicle managed by a financial professional. These let you to invest in multiple stocks managed by the professional instead of you buying each individual stock. These funds focus on replicating performance of a specific financial market or specific category of a stock, such as large company stocks. They don"t need active management so they charge lower fees. You can invest in multiple carious categories of mutual funds. These deal with companies in high-growth industries that are expected to have future earnings growth that is high.

Related Questions

Question 11

Advantages of mutual funds include

	A.	professional management.
	B.	all of these.
	C.	liquidity.
	D.	diversification.

Question 12

Which of the following types of investment companies operates much like an index fund?

	A.	exchange-traded fund
	B.	unit investment trust
	C.	closed-end fund
	D.	REIT

Question 13

A common stock fund that invests in only one industry is called a(n) ____ fund.

	A.	maximum capital gains
	B.	growth and income
	C.	index
	D.	sector

Question 14

Mutual funds that charge a load do so to compensate

	A.	fund managers.
	B.	brokers.
	C.	shareholders.
	D.	the SEC.

Question 15

Your first task in selecting a mutual fund is to

	A.	review your investment policy.
	B.	locate sources of comparative performance data.
	C.	eliminate funds inappropriate for your investment goals.
	D.	screen and compare funds that meet your investment criteria.

Question 16

Taxes on annual earnings from mutual funds can be avoided

	A.	while those amounts are kept in an IRS-qualified retirement account.
	B.	as long as the mutual shares are not sold.
	C.	while those amounts are kept in an IRS-qualified retirement account and if those earnings are interest from municipal bonds.
	D.	if those earnings are interest from municipal bonds.

Question 17

Mutual funds permit automatic income reinvestment of

	A.	ordinary income dividend distribution.
	B.	none of these.
	C.	both ordinary income dividend distributions and capital gains distributions.
	D.	capital gains distribution.

Question 18

The type of mutual fund that is not actively managed is called a(n) ____ fund.

	A.	emerging market
	B.	money market
	C.	index
	D.	sector

Question 19

A mutual fund that does not assess a sales charge at the time of the investment purchase is called a ____ fund.

	A.	back-end load
	B.	front-end load
	C.	low-load
	D.	no-load

Question 20

Open-end mutual funds

	A.	make up about 75 percent of all mutual funds.
	B.	are sold only through brokers.
	C.	are sold at their current net asset value.
	D.	are sold to other investors on a secondary market.

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You recently graduated from Suffolk University, and your job search led you to J&J Bagel, Inc. As you are finishing your employment paperwork, Jerry Chen, one of the co-owners of J&J Bagel, informs you about the companyâs new 401(k) plan. A 401(k) is a type of retirement plan, offered by many companies.

A 401(k) is tax deferred, which means that any deposits you make into the plan are deducted from your current income, so no current taxes are paid on these deposits. For example, if your annual salary is $30,000 and you contribute $1,500 to the 401(k) plan, you will pay taxes only on the $28,500 in income. 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 percent of your salary to the plan. As is common, J&J Bagel has a 5 percent match program. This means that the company will match your contribution dollar-for-dollar up to 5 percent of your salary, but you must contribute to get the match. In other words, if you contribute 5 percent of your $30,000 salary (which is $1,500) towards the 401(k) plan, J&J Bagel will match your contribution by adding another $1,500 to your plan, so that $3,000 in total will be contributed to your 401(k) plan.

The 401(k) plan has several options for investments, most of which are mutual funds. As you know, a mutual fund is a portfolio of assets. When you purchase shares in a mutual fund, you are actually purchasing partial ownership of the fundâs 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 expenses. The largest expense is typically the management fee paid to the fund managers, who make all of the investment decisions for the fund. J&J Bagel uses Imperium Financial Services as its 401(k) plan administrator.

Jerry Chen then explains the following retirement investment options available for employees:

Company Stock. One option is stock in J&J Bagel. The company is currently privately held. The price you would pay for the stock is based on an annual appraisal, less a 20 percent discount. When you are interviewed by the owners, John Benson and Jerry Chen, they informed you that the company stock was expected to be publically sold in three to five years. If you needed to sell the stock before it became publicly traded, the company would buy it back at the then-current appraised value.

Imperium S&P 500 Index Fund. This mutual fund tracks the S&P 500 Index. Stocks in the fund are weighted exactly the same as they are in the S&P 500 Index. This means that the fundâs return is approximately the return of the S&P 500 Index, minus expenses. With an index fund, the manager is not required to research stocks and make investment decisions, so fund expenses are usually low. The Imperium S&P 500 Index Fund charges expenses of 0.20 percent of assets per year.1

Imperium Small-Cap Fund. This fund primarily invests in small capitalization stocks. As such, the returns of the fund are more volatile. The fund can also invest 10 percent of its assets in companies based outside of the U.S. This fund charges 1.7 percent of assets in expenses per year.

Imperium Large-Cap Fund. This fund invests primarily in large capitalization stocks of companies based in the U.S. The fund is managed by Jenna King and has outperformed the market in six out of the last eight years. The fund charges 1.5 percent in expenses.

Imperium Bond Fund. This fund invests in long-term corporate bonds issued by U.S. companies. The fund is restricted to investments in bonds with investment grade credit rating. This fund charges 1.4 percent in expenses.

Imperium Money Market Fund. This fund invests in short-term, high credit quality debt instruments, which include Treasury Bills. As such, the return on money market funds is only slightly higher than the return on Treasury Bills. Because of the credit quality and short-term nature of the investments, there is only a very slight risk of negative return. The fund charges 0.60 percent in expenses.

*1 The return on a mutual fund after accounting for management expenses is calculated as follows. If a fund charges 2 percent in expenses and it is expected to yield a 10 percent return before expenses, then the return on this fund after expenses will be (1 + 0.10)Ã(1 â 0.02) â 1 = 0.078 or 7.8 percent*

QUESTIONS

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

2. One can assess investment risk by looking forward to how assets are expected to react to a particular set of circumstances or âstates of economyâ. Use the following set of assumptions for the coming year to compute the expected rates of return (before expenses) and the standard deviations for the mutual funds described above.

	Probability	S&P 500 index fund	Small-cap fund	large-cap fund	Bondfund	moneymarketfund
Recession	20%	-12%	-30%	-10%	18%	2%
Near Recession	10%	-8%	-20%	-6%	14%	3%
Normal	30%	12%	22%	12%	8%	4%
Near Boom	20%	22%	38%	15%	-1%	5%
Boom	20%	26%	54%	20%	-6%	6%

3. Given the expected returns calculated for each of the mutual funds above, estimate the betas of these funds. Assume a risk-free rate of 4 percent and the expected market return equal to the expected return on the S&P 500 Index.

4. If you decide to invest your money equally in the Small-Cap and Bond funds, what would your portfolioâs expected return and risk level (standard deviation and beta) be? (Hint: Adjust mutual fund returns for management expenses as explained in footnote 1.

5. What would happen if you were to put 70 percent of your portfolio in the Small-Cap fund and 30 percent in the S&P 500 Index fund? Would this combination be better for you?

6. The returns of the Imperium Small-Cap Fund are the most volatile of all the mutual funds offered in the 401(k) plan. Why would you ever want to invest in this fund? When you examine the expenses of the mutual funds, you will notice that this fund also has the highest expenses. Will this affect your decision to invest in this fund?

brownleopard768

You recently graduated from college and accepted a job at M&D, Inc. The HR manager informs you about the companyâs 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 fundâs 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?

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FIN 101 Lecture 8: Easy Investment Management At A Young Age- Purchasing Three or Four Stock Index Mutual Funds

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