The Mutual Fund ProspectusThe mutual fund prospectus is a must-read document for anyone planning to invest in a mutual fund. A mutual fund's prospectus contains information that is crucial to making an informed decision as to whether or not to invest in a particular mutual fund. It can be pretty dry reading, but reading it is definitely worth your while. Mutual funds are obliged to provide you with a prospectus before you invest and subsequently whenever a change is made to the prospectus or every 14 months, whichever occurs sooner. Be sure to check the key aspects whenever you receive a new prospectus or addendum to the prospectus. Objective, strategy, management, advisor and fees are the most important items to check in the mutual fund prospectus. Mutual fund prospectuses can be found on the fund companies' web sites where they can be read online or downloaded for printing or reading at your leisure. Alternatively, you can usually have a printed copy mailed to you. Discount brokerages often provide links to funds' prospectuses. They are obliged to provide, in some form, the prospectuses of any mutual funds that can be purchased through them. At first blush, a mutual fund prospectus may appear to be nothing but boilerplate, but there really is some very useful information to be found in any prospectus. Unlike marketing literature, prospectuses must be very complete, concise and forthright, i.e., they can't be misleading in any way. After you've read a few you'll know what to look for and how to find it without reading every word in the document. You'll find the following important information in every mutual fund prospectus:
Investment Objective can best be explained by providing some examples: long-term capital appreciation, growth and income, income and preservation of capital, and current income, to name a few. Investment Strategy is the means by which the fund manager plans to accomplish the stated objective. The types of securities the fund can invest in and the maximum and/or minimum portion of the portfolio that can be invested in each type should be stated here. Any types of securities that the fund cannot invest in and the maximum percent of the portfolio that can be invested in any one issue should also be stated here. If you don't find this information under Investment Strategy, you will find it elsewhere in the prospectus. Investment Risks are usually fairly obvious to experienced investors but can be a bit unnerving to new investors, especially when presented without the sugar coating applied in marketing literature. There are some risks that apply to just about all funds and others that are specific to certain types of funds. These are covered in detail in the Investing Basics section, but I'll list a few here to give you a general feel for what these are: market risk, company-specific risk (this really only applies to concentrated funds but is often included for good measure), interest rate risk, style risk, currency risk (for unhedged international investments), and the list goes on. The point is to make sure you understand that your choice to invest in the fund will expose your capital to various risks. But that's how you earn your returns. Who should invest? flows from Investment Objective and Investment Risks. The type of investor the fund is suited to is usually stated in general terms based on objectives and risks. Historical Performance is pretty self-explanatory. It's the real deal, comes from audited financial statements and is presented in a format acceptable to the SEC. Unfortunately, it doesn't always include the effects of fees and expenses, so study it carefully in conjunction with the Fees & Expenses section. Fees & Expenses is a very important section. They have to lay it all out on the table for you and provide examples of how your returns would have been and will be affected by the fees and expenses charged by the fund. This section should advise you of any redemption fees that will be assessed on short-term holdings and define "short-term." Usually anyone who is a resident of the U.S., Puerto Rico, Guam, or the U.S. Virgin Islands is eligible to buy shares of a mutual fund formed in the U.S. However, there are some investments that the SEC deems inappropriate for people who don't qualify as high net worth individuals, and some investments are not approved for inclusion in an IRA or 401k. Offhand, I can't think of any mutual funds that fall in the inappropriate or disapproved categories, but with over 8000 of them on the market, I'd be surprised if there aren't a couple that fall in those categories. Types of Accounts refers to regular taxable accounts and the various types of tax-sheltered accounts such as IRAs, Roth IRAs, etc. There's a lot of variation here, so look before you buy. Minimum Investments refers to initial and subsequent investments, and the minimums are usually different (less) for tax deferred and automatic investment accounts. How share price is determined should always be an explanation of how NAV is computed at the end of each trading day and should be essentially the same for all mutual funds formed under SEC rules. This section should bring to your attention things such as the fact that not all securities are done trading for the day when the NY Stock Exchange closes at 4:00 PM EST and that many foreign exchanges do not observe U.S. Holidays, both of which can have significant impacts on NAV on a day-to-day basis. The Purchasing Policies provide basic information on how to buy shares of the fund. The usual options are to establish an account with the fund company, which allows you to bypass any middlemen, or to establish an account with an intermediary such as a full-service or discount brokerage. You will probably also find a statement of the fund's policy regarding excessive short-term trading, a practice they try to limit because it is done at the expense of the shareholders who are in for the long haul and makes it difficult for the fund manager to pursue the fund's objective with the fund's strategy. The Redemption Policies tell you how to go about selling your shares through the fund company or an intermediary. It will also state how and in what form you will receive payment for the shares you redeem. Policies regarding redemption fees will also be stated here. Shareholder Services covers such things as the various reports you will receive, how to handle changes of address and how special accounts, such as IRAs, are handled. Distributions and Taxes describes how distributions from dividends and capital gains are handled, the implications of foreign taxation when applicable, what triggers taxable events for shareholders and what steps shareholders must take to avoid backup withholding on taxable gains. Fund Management is a section that you should keep a close eye on. This section should state who the fund's outside advisor is and the nature of the agreement between the advisor and the fund. More importantly, it should list the fund's managers, their tenure with the fund and their credentials. The most important thing to look for is a manager who has been with the fund for a long time (10 years or more is good) and a co-manager or a younger protégé with good credentials. There can be more than one of each, one of each is the bare minimum. The reasoning behind the strategy of having a co-manager of protégé is succession planning that provides continuity in the management style employed to achieve the fund's long-term objectives. In other words, if the seasoned manager retires or leaves for whatever reason, there will be someone thoroughly indoctrinated by him or her that can carry on in the same manner and is highly likely to obtain the same results. Portfolio Holdings Disclosure Policy is usually just a reference to additional documentation that's available to you regarding the portfolio holdings disclosure policy. If you want to know what securities the fund is holding rather than the fund's policies regarding the disclosure of this information, you should be able to find a list, including the value of each holding, in the fund's annual report. Changes in Objectives Policy states the procedure the fund's management must follow to change the fund's stated objective and the requirements for notifying shareholders of any changes to the objective. For example, a fund may allow changes with the approval of the board of directors but not require shareholder approval, and require that shareholders be notified in writing at least 30 days prior to the implementation of the change. Over time, a mutual fund can experience scope or style drift. So the name of a fund and the category in which it's placed may not accurately reflect its current status. Reading the objective and strategy sections of the mutual fund prospectus will allow you to make your own evaluation of the appropriateness of a fund's name and the category in which it is listed. You can determine if scope or style drift have occurred by reading new prospectuses whenever they show up in your mailbox. As funds' policies, objectives, fees, management and advisors can change over time, you'll want to read any addenda and new prospectuses that are sent to you after you buy shares of a fund. You never know when something important to you might change, and there are a lot of things about a fund that can change that you won't find out about any other way than by reading all the addenda and new versions of the mutual funds' prospectuses as they are issued.
Return to the introduction to mutual fund investing. Move on to the next subsection, "No Load Mutual Funds vs Load Mutual Funds."
|
