Discussion Question 7.1 Comparing Risks of Different Mutual Fund Types
On page 373, answer question L04, #5. You will discuss the risks of different mutual fund types.
*Discussion Question 7.2 Comparing Retirement Plans
On page 402, answer question L04, #6. You will discuss the retirement plans that the different companies are offering in the various scenarios.
*Assignment 7.1 Calculating approximate yield on a mutual fund
On Page 373 of your text, do question L05, #7. It asks you to calculate the approximate yield on
*Assignment 7.2 Calculating Amount available at retirement
On Page 402 of your text, do question L02, #2. It asks you to calculate the amount of money that will be available at retirement given certain variables.
a mutual fund. Use the yield formula we used last week.
Comparing Risks of Different Mutual Fund Types
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Comparing Risks of Different Mutual Fund Types
Discussion Question 7.
Comparing risks of different mutual fund types.
For each pair of funds listed below, select the fund that would be the least risky and briefly explain your answer
- Growth versus growth-and-income
The growth-and-income fund will be the less risky one between the two funds. The growth-and-income fund uses dividends or interest and capital appreciation to increase its value. Stocks and bonds of manure companies are commonly used to generate interest and dividends through the regular dividends they pay (Gitman, Joehnk, & Billingsley, 2015). The use of bonds makes it even safer because bondholders are prioritized over stockholders in terms of interest repayment.
Unlike growth-and-income funds, growth funds use only stocks to generate funds through capital appreciation. This can only favor mature companies with high R&D investments, but the success is still not certain.
- Equity-income versus high-grade corporate bonds
High-grade corporate bonds fund is less risky than equity-income. High-grade corporate focuses on bonds, which are prioritized overs tocks in terms of interest or value repayment. Equity income, on the other hand, depends on regular dividends paid by companies (Gitman, Joehnk, & Billingsley, 2015). Due to changes in the business environment, earnings may be reinvested in the business, making dividends uncertain.
- Intermediate-term bonds versus high-yield municipals
High-yield municipals are less risky than Intermediate-term bonds. High-yield municipals are better because they are issued by government entities, thereby giving them some level of stability (Gitman, Joehnk, & Billingsley, 2015). Government securities have no default risks, making them safer.
- International versus balanced”
A balanced fund is less risky than an international fund. A balanced fund aims to minimize risks while generating income. This is why it gives a range of maximum and minimum values to be considered. International funds, on the other hand, are limited by excluding the investor’s countries (Gitman, Joehnk, & Billingsley, 2015). With this, the investor may not be conversant with ground realities and can only use arbitrage opportunities for gains.
Discussion Question 7.2
Comparing Retirement Plans
Millie Russell has just graduated from college and is considering job offers from two companies. Although the salary and insurance benefits are similar, the retirement programs are not. One firm offers a 401(k) plan that matches employee contributions with 25 cents for every dollar contributed by the employee, up to a $10,000 limit. The other has a contributory plan that allows employees to contribute up to 10 percent of their annual
salary through payroll deduction and matches it dollar for dollar; this plan vests fully after five years. Because Millie is unfamiliar with these plans, she turns to you for help. Explain the features of each plan so Millie can make an informed decision.”
Retirement planning is vital for everyone. It is normally done by investing a small amount of one’s annual savings. However, some factors must be considered to make it more strategic. It should be done on a 3-5-year average to help in accounting for the changes in income and future expectations (Gitman, Joehnk, & Billingsley, 2015). Additionally, people have to consider the standards of living at old ages. There are many retirement plans to choose from. People must understand the various options to make the best choices.
Like in this case, the employer has given M two options to choose from – either a 401(k) plan or a 10% deduction from salary for a contributory plan. With the 401(k) plan, the company will contribute some part of the M’s salary towards a tax-deferred plan. This plan is associated with a maximum contribution of $18,500 or $24,500, tax payment at the withdrawal time, pre-defined contribution plan, and a 10% penalty at withdrawals made before 59.5 of age (Gitman, Joehnk, & Billingsley, 2015). It saves taxes hence considered a tax shelter.
A contribution plan in which the employer and the employee contribute about 3-10% of the employee’s annual salary gets contributions from the employee’s payroll deductions. In this case, the employer will contribute a dollar for each dollar in the plan, along with a 5-year vesting period (Gitman, Joehnk, & Billingsley, 2015). This will be good for M because she is still a graduate – signifying an early age.
M should ask himself these questions before deciding on the best retirement plan. Question concerning eligibility requirements, post-retirement benefits, vesting procedures – be it graded or cliff, employer’s or company’s contributions, recommended retirement age and early retirement implication, the possibility of porting the plan to new employers, and contribution limits (Gitman, Joehnk, & Billingsley, 2015). Such considerations will enable choosing the best retirement plan for the best living standards after retirement.
Assignment 7.1
Calculating Approximate Yield on a Mutual Fund
About a year ago, Elliot Cox bought some shares in the Axis Fund. He bought the fund at $24.50 a share, and it now trades at $26.00. Last year, the fund paid dividends of 40 cents a share and had capital gains distributions of $1.83 a share.
Using the approximate yield formula, what rate of return did Elliot earn on his investment?
= (0.40+1.83+(26.00-24.50)/1)/((26.00+24.50)/2) = 14.7723%
Repeat the calculation using a financial calculator.
N=1
PMT= -0.40 -1.83
FV= -26.00
PV=24.50
CPT I/Y=15.2245%
Would he have made a 20 percent rate of return if the stock had risen to $30 a share?”
N=1
PMT=-0.40-1.83
FV=-30.00
PV=24.50
CPT I/Y=31.5510%
Assignment 7.2
Calculating Amount available at retirement
Molly Lincoln, a 25-year-old personal loan officer at First National Bank, understands the importance of starting early when it comes to saving for retirement. She has committed $3,000 per year for her retirement fund and assumes that she’ll retire at age 65.
- How much will Molly have accumulated when she turns 65 if she invests in equities and earns 8 percent on average?
- Molly is urging her friend, Isaac Stein, to start his plan right away, too, because he’s 35. What would his nest egg amount to if he invested in the same manner as Molly and he, too, retires at age 65? Comment on your findings”
Invested amount = $3000 year
Average return = 8%
Molly’s present age = 25 years
Isaac’s present age = 35 years
Retirement age for both = 65 years
Molly’s investment period is 40 years (65 – 25)
Isaac’s investment period is 30 years (65 – 35)
Calculation of amount available for Molly at retirement ($)
| Year | Opening | Invested | Total | Average Return @ 8% | Closing |
| 1 | 0 | 3000 | 3000 | 240 | 3240 |
| 2 | 3240 | 3000 | 6240 | 499.2 | 6739.2 |
| 3 | 6739.2 | 3000 | 9739.2 | 779.14 | 10518.34 |
| 4 | 10518.34 | 3000 | 13518.34 | 1081.47 | 14599.8 |
| 5 | 14599.8 | 3000 | 17599.8 | 1407.98 | 19007.79 |
| 6 | 19007.79 | 3000 | 22007.79 | 1760.62 | 23768.41 |
| 7 | 23768.41 | 3000 | 26768.41 | 2141.47 | 28909.88 |
| 8 | 28909.88 | 3000 | 31909.88 | 2552.79 | 34462.67 |
| 9 | 34462.67 | 3000 | 37462.67 | 2997.01 | 40459.69 |
| 10 | 40459.69 | 3000 | 43459.69 | 3476.77 | 46936.46 |
| 11 | 46936.46 | 3000 | 49936.46 | 3994.92 | 53931.38 |
| 12 | 53931.38 | 3000 | 56931.38 | 4554.51 | 61485.89 |
| 13 | 61485.89 | 3000 | 64485.89 | 5158.87 | 69644.76 |
| 14 | 69644.76 | 3000 | 72644.76 | 5811.58 | 78456.34 |
| 15 | 78456.34 | 3000 | 81456.34 | 6516.51 | 87972.85 |
| 16 | 87972.85 | 3000 | 90972.85 | 7277.83 | 98250.68 |
| 17 | 98250.68 | 3000 | 101250.7 | 8100.05 | 109350.7 |
| 18 | 109350.7 | 3000 | 112350.7 | 8988.06 | 121338.8 |
| 19 | 121338.8 | 3000 | 124338.8 | 9947.10 | 134285.9 |
| 20 | 134285.9 | 3000 | 137285.9 | 10982.87 | 148268.8 |
| 21 | 148268.8 | 3000 | 151268.8 | 12101.50 | 163370.3 |
| 22 | 163370.3 | 3000 | 166370.3 | 13309.62 | 179679.9 |
| 23 | 179679.9 | 3000 | 182679.9 | 14614.39 | 197294.3 |
| 24 | 197294.3 | 3000 | 200294.3 | 16023.54 | 216317.8 |
| 25 | 216317.8 | 3000 | 219317.8 | 17545.43 | 236863.2 |
| 26 | 236863.2 | 3000 | 239863.2 | 19189.06 | 259052.3 |
| 27 | 259052.3 | 3000 | 262052.3 | 20964.18 | 283016.5 |
| 28 | 283016.5 | 3000 | 286016.5 | 22881.32 | 308897.8 |
| 29 | 308897.8 | 3000 | 311897.8 | 24951.82 | 336849.6 |
| 30 | 336849.6 | 3000 | 339849.6 | 27187.97 | 367037.6 |
| 31 | 367037.6 | 3000 | 370037.6 | 29603.01 | 399640.6 |
| 32 | 399640.6 | 3000 | 402640.6 | 32211.25 | 434851.9 |
| 33 | 434851.9 | 3000 | 437851.9 | 35028.15 | 472880 |
| 34 | 472880 | 3000 | 475880 | 38070.40 | 513950.4 |
| 35 | 513950.4 | 3000 | 516950.4 | 41356.03 | 558306.4 |
| 36 | 558306.4 | 3000 | 561306.4 | 44904.52 | 606211 |
| 37 | 606211 | 3000 | 609211 | 48736.88 | 657947.8 |
| 38 | 657947.8 | 3000 | 660947.8 | 52875.83 | 713823.7 |
| 39 | 713823.7 | 3000 | 716823.7 | 57345.89 | 774169.6 |
| 40 | 774169.6 | 3000 | 777169.6 | 62173.56 | 839343.1 |
Calculation of amount available for Isaac at retirement ($)
| Year | Opening | Invested | Total | Average Return @ 8% | Closing |
| 1 | 0 | 3000 | 3000 | 240 | 3240 |
| 2 | 3240 | 3000 | 6240 | 499.2 | 6739.2 |
| 3 | 6739.2 | 3000 | 9739.2 | 779.14 | 10518.34 |
| 4 | 10518.34 | 3000 | 13518.34 | 1081.47 | 14599.8 |
| 5 | 14599.8 | 3000 | 17599.8 | 1407.98 | 19007.79 |
| 6 | 19007.79 | 3000 | 22007.79 | 1760.62 | 23768.41 |
| 7 | 23768.41 | 3000 | 26768.41 | 2141.47 | 28909.88 |
| 8 | 28909.88 | 3000 | 31909.88 | 2552.79 | 34462.67 |
| 9 | 34462.67 | 3000 | 37462.67 | 2997.01 | 40459.69 |
| 10 | 40459.69 | 3000 | 43459.69 | 3476.77 | 46936.46 |
| 11 | 46936.46 | 3000 | 49936.46 | 3994.92 | 53931.38 |
| 12 | 53931.38 | 3000 | 56931.38 | 4554.51 | 61485.89 |
| 13 | 61485.89 | 3000 | 64485.89 | 5158.87 | 69644.76 |
| 14 | 69644.76 | 3000 | 72644.76 | 5811.58 | 78456.34 |
| 15 | 78456.34 | 3000 | 81456.34 | 6516.51 | 87972.85 |
| 16 | 87972.85 | 3000 | 90972.85 | 7277.83 | 98250.68 |
| 17 | 98250.68 | 3000 | 101250.7 | 8100.05 | 109350.7 |
| 18 | 109350.7 | 3000 | 112350.7 | 8988.06 | 121338.8 |
| 19 | 121338.8 | 3000 | 124338.8 | 9947.10 | 134285.9 |
| 20 | 134285.9 | 3000 | 137285.9 | 10982.87 | 148268.8 |
| 21 | 148268.8 | 3000 | 151268.8 | 12101.50 | 163370.3 |
| 22 | 163370.3 | 3000 | 166370.3 | 13309.62 | 179679.9 |
| 23 | 179679.9 | 3000 | 182679.9 | 14614.39 | 197294.3 |
| 24 | 197294.3 | 3000 | 200294.3 | 16023.54 | 216317.8 |
| 25 | 216317.8 | 3000 | 219317.8 | 17545.43 | 236863.2 |
| 26 | 236863.2 | 3000 | 239863.2 | 19189.06 | 259052.3 |
| 27 | 259052.3 | 3000 | 262052.3 | 20964.18 | 283016.5 |
| 28 | 283016.5 | 3000 | 286016.5 | 22881.32 | 308897.8 |
| 29 | 308897.8 | 3000 | 311897.8 | 24951.82 | 336849.6 |
| 30 | 336849.6 | 3000 | 339849.6 | 27187.97 | 367037.6 |
Comment
Molly Lincoln will have $ 839343.1 at retirement
Isaac Stein will have $ 367037.6 at retirement of
Molly will have a larger amount compared to Isaac because she started investing earlier. Apparently, early investment is associated with larger compounding benefits.
References
Gitman, L. J., Joehnk, M. D., & Billingsley, R. (2015). PFIN 4. Cengage Learning.