YOUR $401($k$)$ ACCOUNT AT EAST COAST YACHTS

You have been at your job with East Coast Yachts for a week now and have decided you need to sign up for the company's

$401(k)$ plan. Even after your discussion with Sarah Brown, 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 fund. You have also 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 not certain

of 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 $500$ is one of the world's largest equity index mutual funds. It

replicates the S&P $500,$ and its 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 $401(k)$ plan, but it has been in existence for much

longer, so you can study its track record for over two decades. The graph below summarizes Dan's comments by showing the

percentage of equity mutual funds that outperformed the Vanguard $500$ Fund over the previous $10$ years. ${?}^{19}$ So$,$ for example,

from January $1989$ to December $1998,$ only about $16$ percent of equity mutual funds outperformed the Vanguard $500.$ Dan

suggests that you study the graph and answer the following questions:

What implications do you draw from the graph for mutual fund investors?

Is the graph consistent or inconsistent with market efficiency? Explain carefully.

What investment decision would you make for the equity portion of your $401(k)$ account? Why?