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?