Question

Historically the S&P 500 Stock Index has returned about 8% a year but returns are very uneven as recent experience has reminded us - the INDEX declined by more than 50% from its peak in 2007 and took 7 years to attain that peak level again. This year (2019) the S & P 500 Index has gained about 10% through today’s date after declining almost 10% for last year( 2018). It has since recovered. In contrast a typical Money Market Fund has returned about 2% a year with minimal fluctuation. Given this, evaluate the following:

d) How risky would it be if you planned to use the Money Market fund as the major component of your retirement fund, 40 years from now? Briefly discuss your perception of risk in this decision, given your objective!

Very low                                                                                               Very high

                 risk              ____    ____    ____    ____    ____    ____    ____        risk

                                       1          2          3       4        5           6          7

            .

Briefly explain your decision: (2 points)

Answer 1

Money market funds are open ended funds which invest in short term securities having an average maturity of 1 year. It invests in high quality liquid instruments like treasury bills, commercial papers, certificate of deposits and repurchase agreements. The volatility of these funds is minimum.

Money market funds suffer from interest rate risk, credit risk and reinvestment risk. Since they are mostly backed by the Government the credit risk is very low. If we compare these funds from market index funds, they are less risky. Unlike the equity index funds which has both systematic and unsystematic risk, money market funds mostly have systematic risk only. For retirement purpose, investment in money market funds is very less risky- a rating more than cash and savings account - 2. However, it s not an ideal investment as money market investments are short term securities and not an investment for long period like 40 years.