Case Study: “the Vanguard Group in 2006 and Target Retirement Funds.”

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1. Briefly summarize the key features of Vanguard’s business philosophy. Vanguard is committed to a philosophy of cost minimization and high-quality service to its clients-shareholders. Vanguard offers its services on an at-cost basis because the company is owned by the mutual funds it distributes, or indirectly by investors in those mutual funds. Minimizing costs for Vanguard translates into maximizing profits for its shareholders and clients. Providing high-quality services aims at guaranteeing client satisfaction. Vanguard’s success is largely attributable to the word-of-mouth advertising by its clients; this allows Vanguard to minimize its marketing/advertising costs, thus reducing overall costs furthermore. 2. What are the two main theoretical arguments for reducing one’s stock allocation as one grows older? The first argument is that human wealth could be viewed as an asset with bond-like characteristics. The value declines as people age, since the present value of earnings and benefits (coupons) becomes smaller as one nears retirement. As a result, young investors, whose human wealth is largely allocated in this bond-like portfolio, should weight their investments towards equities to balance out the bond-like value of their human wealth, and as that bond-like value decreases with age, so should one’s investments in equities. The second argument is that stocks are mean reverting: the volatility of return diminishes as the time-horizon increases. As young investors face a much longer time horizon, their risks are reduced, making them more willing to weight the portfolio toward equities.
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