Advantages of Mutual Funds and 401ks Essay

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The Benefits of Mutual Funds and Employers Matching Employees’ Pension Contributions 




Question 1



Investing in a mutual fund has major advantages compared with investing in the company stock. The first benefit is diversification of risk. Mutual funds invest in many different companies, often across different industries (Bogle, 2015). This means if the value on one share in the portfolio falls, or evens collapses, it will not result in a significant decline in portfolio value (Bogle, 2015). This reduces the risk when compared to any investment in a single stock, where a change in the share price will impact directly on the value of the investment (Bogle, 2015). The purchase price of the investment units in the mutual fund will also reflect market condition, as they are determines by the underlying asset prices (Howells & Bain, 2007). This is an advantage compared to the company stock, as the firm is currently private, with the prices set not by market condition, but by the directors which may result in biased valuation and increased risk of potentially over paying for shares. In addition, the mutual fund is more liquid, as the underlying assets are more easily tradable compared to private shares (Howells & Bain, 2007), and there is no guarantee that the company will go public.

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Question 2

    

The EAR is the annual equivalent rate, returning to the rate of return that is received calculated as an annual return (Investopedia, 2016). In this scheme it is stated that a 5% contribution of salary will be matched by the firm. If the new employee is on a salary of $50,000, the following will be the contributions for the year.   



Table 1; Total pension contribution

Salary    50,000

Employee contribution    2,500

Employer contribution     2,500

Total contribution     5,000



The calculation of an EAR is undertaken to assess a return when there are payments received on an investment over a period of time, with the calculation often needed due to the compounding effect; where interest is paid on the total value of an investment, which can include the interest from previous periods (Investopedia, 2016). However, in this case, looking only at the EAR that is gained from the matching process, and not any additional gains made by the underlying investment, there is no….....

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References


Bogle, J. C. (2015). Bogle On Mutual Funds: New Perspectives For The Intelligent Investor. London: John Wiley & Sons.

Howells, P. G. A., & Bain, K. (2007). Financial Institutions and Markets. London: Longman.

Investopedia. (2016), Annual Equivalent Rate – AER. [online] Accessed at <http://www.investopedia.co

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