Question

Mutual Fund Data-Sets for 401k Plan Investment Options) It is 02.26.2019. Your 401k plan at work is introducing some new investment options. You are given the “MarketWatch” or “Watch” three-page PDF printout which compares these 4 Mutual Funds now available within your plan, all of which specialize in small/mid-cap or emerging growth companies. You may head Fama & French (two researchers) believe that small-cap firms can often outperform their ‘expected” returns. However, you took him too literally and want to overweight the sector investing 50% of your total 401k in one of these funds. The presenter at your firm can’t give you advice but mentions the following: A) All four options are well diversified and don’t have more than 3% of their portfolios in any one stock; B) Since within a tax deferred retirement plan, tax efficiency (how much income comes from gains vs, dividends) is not an issue when comparing the funds; C) Despite any reference to Load Fees or “up front sales charges”, they do not exist for your 401k Plan since your company is large enough to have negotiated these away… so all investment options have zero up-front fees; D) All are Morningstar 4 or 5-star rating. You go home and do more research since you feel that MarketWatch doesn’t have a huge amount of Data. You pull-down lots of data from E*Trade, but it mostly replicates the summary information from MarketWatch received at work. A friend at work askes how you are going to make a decision as to which of the 4 investment options you will select. What are the top 4-or-5 things that you tell them about the fund characteristics which are influencing your decision?

Answer 1

1. Small-cap and Mid-cap companies are emerging companies. There are a large number of small-cap companies listed compared to mid-caps and a few large-cap companies are available compared to mid-caps and small caps. Large caps are well-established companies compared to mid caps and small caps and less risky compared to mid and small caps. When we compare Mid caps with small caps mid caps are less risky than small-cap companies.

2. It is not advisable to overweight small caps as it is highly risky. A small change in the perception of investors towards the company can cause a huge price difference. Mid-caps are more stable than small-caps.

3. It is important to note which sector the mutual funds are investing. The Pharma and FMCG sector will always have a demand for its products. It is important to invest it in different sectors which are stable and booming. If a future of a particular sector such as Banking or real estate is not good then highly growing companies may fall.

4. The future of the company is more important than past historical data or earnings. It is important to look carefully that some of the companies in which you are investing are undervalued. Undervalue doesn't mean the lowest but the value of the company that you get is more than the price that you pay.

5. It is always advisable to invest in mutual funds that invest more in midcaps than small caps. 80:20 is the ideal ratio from the perspective of an ideal investor.