Your next door neighbor, Scott Jansen, has a 12-year old daughter, and he wants to pay the tuition for her first year of college 6 years from now. The tuition for the first year will be $17,500. Scott has gone through his budget and finds that he can invest $200 per month for the next 6 years. Scott has opened accounts at two mutual funds. The first fund follows an investment strategy designed to match the return of the S&P 500. The second fund invests in short-term Treasury bills. Both funds have very low fees.
Scott has decided to follow a strategy in which he contributes a fixed fraction of the $200 to each fund. An advisor from the first fund suggested that each month he invest 80% of the $200 in the S&P 500 fund and the other 20% in the T-Bill. The advisor explained that the S&P 500 has averaged much larger returns than the T-bill fund. Even though stock returns are risky investments in the short run, the risk would be fairly minimal over the longer 6-year period. An advisor from the second fund recommended just the opposite: invest 20% in the S&P 500 fund and 80% in T-bills. Treasury bills are backed by the United States government. If you follow this allocation, he said, your average return will be lower, but at least you will have enough to reach your $17,500 target in 6 years.
Not knowing which advisor to believe, Scott has come to you for help.
a. The attached file contains 261 monthly returns of the S&P 500 and Treasury bills. Suppose that in each of the next 72 months (6 years) it is equally likely that any of the historical returns will occur. Develop a spreadsheet model to simulate the two suggested investment strategies over the 6-year period. Plot the value of each strategy over time for a single iteration of the simulation.
b. What is the total value of each strategy after 6 years?
Develops a spreadsheet model to simulate the two suggested investment strategies over the 6-year period.