Question: You recently graduated from college, and your job search led you to East coast Yachts. Since you felt the company’s business was seaworthy, you accepted a job offer. The first day on the job, while you are finishing your employment paperwork, Dan Ervin, you working in Finance, stops by to inform you about the company’s 401(k) plan. A 401(k) plan is a retirement plan offered by many companies. Such plans are tax-deferred savings vehicles, meaning that any deposits you make into the plan are deducted from your current pretax income, so no current taxes are paid on the money. For example, assume your salary will be $50,000 per year. If you contribute $3,000 to the 401(k) plan, you will only pay taxes on $47,000 in income. There are also no taxes paid on any capital gains or income while you are invested in the plan, but you do pay taxes when you withdraw money at retirement. As is fairly common, the company also has a 5 percent match. This means that the company will match your contribution up to 5 percent 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. A mutual fund is a portfolio of assets. When you purchase shares in a mutual fund, you are actually purchasing partial ownership of the fund’s assets. The return of the fund is the weighted average of the return of the assets owned by the fund, minus any expenses. The largest expense is typically the management fee, paid to the fund manager. The management fee is compensation for the manager, who makes all of the investment decisions for the fund. East Coast Yachts uses Bledsoe Financial Services as its 401(k) plan administrator. The investment options offered for employees are discussed below. Company Stock
One option in the 401(k) plan is stock in East Coast Yachts. The company is currently privately held. However, when you interviewed with the owner, Larissa Warren, she informed you the company stock was expected to go public in the next three to four years. Until then, a company stock price is simply set each year by the board of directors.
Bledsoe S&P 500 Index Fund
This mutual fund tracks the S&P 500. Stocks in the fund are weighted exactly the same as the S&P 500. This means the fund return is approximately the return on the S&P 500, minus expenses. Since and index fund purchases assets based on the composition of the index it is following, the fund manager is not required to research stocks and make investment decisions. The result is that the fund expenses are usually low. The Bledsoe S&P 500 Index Fund charges expenses of .15 percent of assets per year.
Bledsoe Small Cap Fund
The 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 the United States. This fund charges 1.70 percent in expenses.
Bledsoe Large Company Stock Fund
This fund invests primarily in large capitalization stocks of companies based in the United States. The fund is managed by Evan Bledsoe and has outperformed the market in six of the last eight years. The fund charges 1.50 percent in expenses.
Bledsoe Bond Fund
This fund invests in long-term corporate bonds issued by U.S. domiciled companies. The fund is restricted to investments in bonds with an investment grade credit rating. This fund charges 1.40 percent in expenses.
Bledsoe Money Market Fund
This fund invests in short-term, high credit quality debt instruments, which include Treasury bills. As such, the return on the money market fund 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 charge .60 percent in expenses.
6. What portfolio allocation would you choose? Why? Explain your thinking carefully.
I would select my portfolio allocation to be as follows: 35 percent Bledsoe S&P 500 Index Fund, 35 percentBledsoe Large Company Stock Fund, 20 percent bonds and 10 percent money market funds. This is based on the assumption that the 5 percent match that the company offers will be in company stock.
This allocation holds relatively high risk, with a substantial portion being directly affected by the fluctuations of the S&P and the stock prices of large companies. However, given my young age I feel that this risk is justified in maximizing the amount within my retirement fund. It is best to have a risky portfolio when I have several years until retirement so that I have time to rebuild my retirement fund if I would suffer a serious loss.
I would select the Bledsoe S&P 500 Index Fund due to the low cost involved and the fact that I can maintain an idea of how much I can expect in returns by monitoring the S&P Index. Next, I would select the Bledsoe Large Company Stock Fund because it has outperformed the market in six of the last eight years. This holds the potential to truly maximize the value of my retirement fund. The disadvantage of choosing this investment option is the high management fees, however, with the high rate of expected returns I feel the cost is justified. I also chose a portion of the portfolio to be allocated to Bonds and Money Market investment options as these are more stable investment options and hold less risk to my overall retirement fund.
Overall, it is important that I carefully examine the costs associated with each investment optionas well as the level of risk involved. It is better to hold a risky portfolio allocation early on in my career so I have time to make any adjustments and recover losses that may be incurred from the risky investments. I would, of course, discuss this allocation with the representative in charge of the 401 (k) but would want to maintain a similar allocation as discussed here.