FIN 420 Week 4 Investing, Risk and Return Example

The Unclaimed Match, a Roth Question and a 529 for Maya: Putting the Whitfields' First Investment Dollars Where They Earn the Most

[Student Name]

University of Phoenix

FIN/420: Personal Financial Planning

Week 4 Assignment

[Instructor Name]

[Date]

The Whitfields, their plans and all figures are composites written for a model paper; account rules, tax treatment and research findings come from the sources listed, are stated generally and change over time.

With an emergency fund under way and a balance transfer paying off their cards, the Whitfields, the composite Phoenix couple, asked how to invest. Jasmine contributes 3 percent of her pay to her dental practice's 401(k). Andre contributes to the city's pension plan as required and has never looked at the city's voluntary 457(b) deferred compensation plan. Both retirement accounts sit in whatever funds were chosen by default. They also want to start saving for Maya's education and for a house. Before choosing a single fund, the couple needed to know which account each dollar should go into, because the right order can be worth more than the right fund. This paper sets that order.

Risk, Return and Time

Investments that offer higher expected returns, such as stocks, also swing more in value. Over long horizons, the higher average return of stocks has tended to outweigh their swings, while over a few years a stock-heavy portfolio can lose a large share of its value and fail to recover in time (Bodie et al., 2021). Planning texts treat each goal's horizon as the first guide to how much risk it can carry (Kapoor et al., 2020). The couple's goals have very different horizons: the house in about four years, Maya's education in 14 years and retirement in 30 years or more. Each goal therefore gets its own risk level.

The Unclaimed Match

Jasmine's practice matches 100 percent of contributions up to 4 percent of pay. At 3 percent, she gives up a match of 1 percent of her $54,000 salary, $540 a year, an instant 100 percent return on the extra contribution. Raising her contribution to 4 percent costs about $34 a month in take-home pay after the tax deduction. Choi et al. (2011) found that many employees whose plans offered an immediate, risk-free gain from the match, including some who could withdraw without penalty, still failed to contribute enough to receive it, leaving money unclaimed. Capturing the match is the first investment step.

Traditional or Roth?

Jasmine's plan offers both traditional and Roth contributions. Traditional contributions are deducted from taxable income now and taxed when withdrawn; Roth contributions are taxed now and withdrawn tax free in retirement if rules are met. The couple's federal marginal rate is 22 percent, and Arizona's flat income tax rate is 2.5 percent. In retirement, with a pension, Social Security and savings, they may well be in a similar bracket. When rates are expected to be similar, the two choices produce similar results, and Roth contributions add flexibility and protection against future tax increases. The couple split their new contributions evenly between the two, a hedge against uncertainty about future tax law.

Andre's 457(b)

The city's 457(b) plan accepts voluntary contributions on top of the pension. Unlike most employer plans, withdrawals from a governmental 457(b) after leaving the employer are not subject to the usual 10 percent early-withdrawal penalty, which gives the account flexibility. Andre will start at 3 percent of pay, about $160 a month, increasing by one point each year as the Week 1 plan frees cash.

Choosing Funds

Both plans offer target-date funds, which hold a mix of stocks and bonds that becomes more conservative as the target year approaches, and low-cost index funds. Jasmine's default fund was an actively managed balanced fund with an expense ratio of 0.95 percent; the plan's 2060 target-date index fund charges 0.12 percent. On a balance growing toward $300,000, the difference is about $2,500 a year. The couple moved both accounts to target-date index funds, which handle diversification and rebalancing automatically and suit investors who do not want to manage allocations themselves.

Money for the House

The down payment fund must be available in about four years. A stock-heavy portfolio could lose a quarter of its value in a bad year, delaying the purchase. The house fund will sit in a high-yield savings account or short-term Treasury bills, earning less but keeping the money intact. The couple accepts the lower return as the price of certainty about the purchase date.

Maya's Education

A 529 plan grows tax free when used for qualified education costs, and Arizona allows a state income tax deduction for contributions up to an annual limit. The couple opened an Arizona plan account using an age-based portfolio that starts with more stocks and shifts toward bonds as Maya approaches college. They will contribute $100 a month after the card payoff ends, and ask grandparents to contribute for birthdays. At a 6 percent return, $100 a month for 14 years grows to about $26,200, a start toward the $80,000 goal.

The Funding Order

As cash frees up, the couple will add to accounts in this order: first, Jasmine's contribution to 4 percent to capture the full match; second, the emergency fund to $15,000; third, the house fund on schedule; fourth, Andre's 457(b), rising one point a year; fifth, Maya's 529; and finally, additional retirement savings through Roth IRAs once the house is purchased.

Beneficiaries and Account Housekeeping

Opening accounts is also the moment to name beneficiaries. Jasmine's 401(k) still listed her mother, from before the marriage. Retirement accounts pass to the named beneficiary regardless of a will, so the couple updated every account to name each other first and, once their wills are signed, a trust for Maya second. They also consolidated logins and set a calendar reminder each January to confirm contribution rates after raises.

Risk Tolerance Check

Jasmine asked whether they could handle a market drop. In 2022, a typical 2060 target-date fund fell close to 20 percent. With their current balances, a similar drop would mean a paper loss of about $9,000. Because they do not need the money for decades and their emergency and house funds are separate, a decline would not force a sale. Knowing that in advance makes it less likely they would panic.

Conclusion

The Whitfields' best investment move costs $34 a month and earns an immediate 100 percent: capturing Jasmine's full match. A split between traditional and Roth contributions, Andre's 457(b), low-cost target-date funds, safe accounts for the house and an age-based 529 for Maya put each goal in an account with the right tax treatment and the right amount of risk.

References

Bodie, Z., Kane, A., & Marcus, A. J. (2021). Investments (12th ed.). McGraw Hill.

Choi, J. J., Laibson, D., & Madrian, B. C. (2011). $100 bills on the sidewalk: Suboptimal investment in 401(k) plans. The Review of Economics and Statistics, 93(3), 748-763. https://doi.org/10.1162/REST_a_00100

Kapoor, J. R., Dlabay, L. R., Hughes, R. J., & Hart, M. M. (2020). Personal finance (13th ed.). McGraw Hill Education.