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A Job at 5&5 Air You recently graduated from college, and yourjob search led you to 5&5 Air. Because you felt the company's business was headed skyward, you accepted the job offer. As you are nishing your employment paperwork, Chris Guthrie, who works in the finance department, stops by to inform you about the company's new 401(k) plan. A 401(k) is a type of retirement plan offered by many companies. A 401(k) is tax deferred, which means that any deposits you make into the plan are deducted from your current income, so no current taxes are paid on the money. Assume your salary will be $40,000 per year. If you contribute $3,000 to the 401(k) plan, you will pay taxes only on $37,000 in income. 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 percent of your salary to the plan. As is common, 5&5 Air also has a 5 percent match program. This means that the company will match your contribution dollarfordollar 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. As you know, a mutual fund is a portfolio of assets. When you purchase shares in a mutual fund, you are actually purchasing partial ownership ofthe fund's assets, similar to purchasing shares of stock in a company. The return of the fund is the weighted average ofthe return ofthe assets owned by the fund, minus any expenses. The largest expense is typically the management fee paid to the fund manager, who makes all of the investment decisions for the fund. 5&5 Air uses Arias Financial Services as its 401(k) plan administrator. Chris Guthrie then explains that the retirement investment options offered for employees are as follows: 1. Company stock. One option is stock in 5&S Air. The company is currently privately held. The price you would pay for the stock is based on an annual appraisal, less a 20 percent discount. When you interviewed with the owners, Mark Sexton and Todd Story, they informed you that the company stock was expected to be publicly sold in three to five years. If you needed to sell the stock before it became publicly traded, the company would buy it back at the thencurrent appraised value. 2. Arr'as S&P 500 Index Fund. This mutual fund tracks the S&P 500. Stocks in the fund are weighted exactly the same as they are in the S&P 500. This means that the fund's return is approximately the return ofthe S&P 500, minus expenses. With an index fund, the manager is not required to research stocks and make investment decisions. so fund expenses are usually low. The Arias S&P 500 Index Fund charges expenses of .20 percent of assets per year. 3. Arr'as Small-Cap Fund. This fund primarily invests in small capitalization stocks. As such, the returns of the fund are more volatile. The fund also can invest 10 percent of its assets in companies based outside the United States. This fund charges 1.70 percent of assets in expenses per year. 4. Arr'as LargeCompany Stock Fund. This fund invests primarily in large capitalization stocks of companies based in the United States. The fund is managed by Melissa Arias and has outperformed the market in six of the last eight years. The fund charges 1.50 percent in expenses. 5. Arr'as Bond Fund. This fund invests in longterm 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. 6. Arr'as Money Market Fund. This fund invests in shortterm, nighcreditquality debt instruments, which include Treasury bills. As such, the return on money market funds is only slightly higher than the return on Treasury bills. Because of the credit quality and short-term nature ofthe investments, there is only a very slight risk of negative return. The fund charges .50 percent in expenses. QUESTIONS 1. What advantagesldisadvantages do the mutual funds offer compared to company stock for your retirement investing? 2. Notice that, for every dollar you invest, 8&5 Air also invests a dollar. What return on your investment does this represent? What does your answer suggest about matching programs? 3. Assume you decide you should invest at least part of your money in large capitalization stocks of companies based in the United States. What are the advantages and disadvantages of choosing the Arias LargeCompany Stock Fund compared to the Arias S&P 500 Index Fund? 4. The returns of the Arias SmallCap Fund are the most volatile of all the mutual funds offered in the 401(k} plan. Why would you ever want to invest in this fund? When you examine the expenses ofthe mutual funds, you will notice that this fund also has the highest expenses. Will this affect your decision to invest in this fund? 10-Year Annual Standard Return Deviation Arias S&P 500 Index Fund 11.80% 19.35% Arias Small-Cap Fund 15.12 27.95 Arias Large-Company Stock 11.15 21.16 Fund Arias Bond Fund 7.92 11.45
