Question: 401 (k) SSAIR Retirement Plan Options Notes: · Tax-deferred (deposits
ID: 2783844 • Letter: Q
Question
Question:
401 (k) SSAIR Retirement Plan Options
Notes:
· Tax-deferred (deposits made into plan are deducted from pretax income). No current taxes paid on that money
· If salary was $50,000 per year, contributing $3000 to 401(k), pay taxes on only $47,000 income.
· No taxes paid while invested in plan, but you pay taxes when you withdrawal at retirement
· Company has a 5% match. (will pay up to 5% match of salary but you need to contribute to get match).
401 (k) Option Notes
· Most mutual funds (portfolio of assets)
· Return of find is weighted average of return of assets owned by fund, minus any expenses.
· Largest expense typically is management fee to fund manager (who makes all investment decisions for the fund).
Investment Options
· Company Stock
o Currently privately held
o Company stock expected to go public in 3-4 years (until then, price set by board of directors).
· B. S&P 500 Index Fund
o Mutual Fund that tracks S&P 500.
o Stocks in fund weighted = S&P 500
o Fund return ~ the return on S&P 500 minus expenses
o Index fund purchases assets based on composition of index, the fund manager not required to research stocks and make investment decisions. (results in low fund expenses).
o Charges 15% of assets per year
· B. Small-Cap Fund
o Primarily invests in small-capitalization stocks. (returns on funds more volatile
o Fund can also invest 10% of its assets in companies based outside of U.S.
o Charges 1.70% in expenses
· B. Large- Company Stock Fund
o Primarily invests in large-capitalization of stocks of companies based in the U.S.
o Funds managed by B. Company owner (outperformer of market for the last 6 of 8 years)
o Charges 1.50% in expenses
· B. Bond Fund
o Invests in long-term corporate bonds issued by U.S. domiciled companies.
o Restricted to investment bonds with investment-grade credit rating
o Charges 1.40% in expenses
· B. Money Market Fund
o Invests in short-term, high credit quality instruments (including treasury bills)
o Return on money market fund is only slightly higher than the return on treasury bills.
o Credit quality and nature of short-term, make it slight risk of negative return
o Charges .60% in expenses.
1. What advantages do the mutual funds offer compared to the company stock? key facts of the case and describe the decision that needs to be made by new employee
Explanation / Answer
Mutual funds offered have multiple advantages over the offered company stock. This is because the return on investment in company stock is depenedent only on performance of that specific company, however, investment in mutual fund chosen is spread over a group of companies. Hence, the risk gets diversified. Low performance of company will result in setting of lower price by the company board, whereas the mutual funds are managed by professionals who keep a track of performing companies and do shuffle their investments from time to time. Moreover, depending on risk of the investor, he can chose between the small cap fund, large cap fund, S&P Fund or the bond fund. This option is not available when he chooses to invest in Company stock.
The employee should rather choose to invest in mutual fund seeing the advantages listed above except the S&P 500 Fund where the expense ratio is too high i.e. 15% of assets. Such a high expense ratio will annually erode the returns by same percentage, thus leading to high risk of low returns. If there is an option to split his investments in both company stock and mutual funds (except S&P Fund), he can take somewhat risk considering his youung age by investing 20-25% in company stock also. It has been witnessed historically that companies do tend to outperform markets over long term. In this case, a mix of assets will generate healthy returns in his portfolio and thus, he will be able to retire with a handsome amount in his kitty. Diversified mutual funds usually perform in tandem with the market over long term and since this is a retirement plan, he can choose to opt a mix of it.
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