Question

In 20XX the stock market crashed and decreased in value by 47%. Jose and John each had $500,000 in a mutual fund that was now worth $265,000. Jose sold the mutual fund for $265,000 obtaining a taxable loss of $235,000. He took his $265,000 and invested in another fund that had also gone down 47%. His friend John told Jose he was crazy, pouring good money after bad. John pulled out his money and put it in the bank to earn 2% interest.

In three years’, time the market had gone back up. Jose’s new fund was now worth $500,000. When the fund spun off taxable capital gains, Jose didn’t have to pay tax on the capital gains because he had $235,000 in taxable losses to deduct again the gains. He could also deduct $3000 per year against his dividends to reduce the tax he had to pay on the dividends.

A) How much money do you think John had?

B) If you know you are going to need your money for college tuition or a down payment for a house within the next couple of years, should you put it in the bank or invest in stocks?

Answer 1

1. How much money John had?

John had $5000,000 in a mutual fund. After that the market crashed by 47% and hence the value was now $265,000. He took his $265,000 and invested in a bank to earn 2% interest. So after 3 years, John will have $281,220.12 (265000*1.02*1.02*1.02).This is after assuming that there were no other deposits and withdrawals from the bank account and 2% interest is per annum.

2. If money is needed after two years then one should invest in bank as interest income will be fixed and money will stay secure as against in stocks where value depends on market and it may happen that market crashes and we end up with minimal value. Investing in bank will give lower but fixed returns to the investor hence it is considered as safer investment when compared with investment in stocks.