Question:
Your 401(K) Account at East coast yachts?
Your 401(K) Account at East coast yachts? You have been at your job for East Coat Yachts for a week now and have
decided you need to sign up for the company’s 401(k) plan. Even after
your decision with XXXXX XXXXX, the Bledsoe Financial Services
Representative, you are still unsure as to which investment option you
should choose. Recall that the options available to you are stock in
East Coast Yachts, the Bledsoe S&P 500 index fund, the Bledsoe Small-cap
fund, the Bledsoe Large-Company Stock Fund, the Bledsoe Bond Fund, and
the Bledsoe Money Market Fund. You have decided that you should invest
in a diversified portfolio, with 70 percent of your investment in
equity, 25 percent in bonds, and 5 percent in the money market. You
have decided to focus your equity investment on large-cap stocks, but
you are debating whether to select the S&P 500 Index fund or the
Large-Company Stock Fund.
In thinking it over, you understand the basic difference in the two
funds. One is a purely passive fund that replicates a widely followed
large-cap index, the S&P 500, and has low fees. The other is actively
managed with the intention that the skill of the portfolio manager will
result in improved performance relative to an index. Fees are higher in
the latter fund. You’re just not certain on which way to go, so you
ask Dan Ervin, who works in the company’s finance area, for advice.
After discussing your concerns, Dan gives you some information
comparing the performance of equity mutual funds and the Vanguard 500
index fund. The Vanguard 500 in the world’s largest equity index
mutual fund. It replicates the S&P 500, and it’s return is only
negligibly different from the S&P 500. Fees are very low. As a result,
the Vanguard 500 is essentially identical to the Bledsoe S&P 500 index
fund offered in the 401k plan, but it has been in existence for much
longer, so you can study its track record for over two decades. The
graph on the following page summarizes Dan’s comments by showing the
percentages of equity mutual funds that outperformed the Vanguard 500
fund over the previous ten years. So for example, from January 1977 to
December 1986, about 70 percent of equity mutual funds outperformed the
Vanguard 500. Dan suggests that you study the graph and answer the
following questions:
1. What implications do you draw from the graph for mutual fund
investors?
2. Is the graph consistent or inconsistent with market efficiency?
Explain carefully.
3. What investment decision would you make for the equity portion of
your 401k account? Why?
