Learning how to read the simplified prospectus is a vital part of mutual funds investing. A simplified prospectus provides details about an investment, including information on its objectives and management. The prospectus discusses fees, mutual fund returns and the risks investors take when they buy mutual funds. Since the Securities and Exchange Commission (SEC) standardized the prospectus format, all prospectuses now contain similar sections and headings that satisfy the SEC’s disclosure requirements. Because prospectuses are so alike, you only need to learn how to read one to apply those skills over a lifetime of mutual funds investing. You do, however, have to understand the prospectus if you want to control fees and improve your mutual fund returns.
Read the Fee Schedule Before You Buy Mutual Funds
The first 10 to 30 pages of the simplified prospectus are devoted almost exclusively to the explanation of fees and risks. As this information applies to every fund in the prospectus and certain funds may be sold in different versions or series, investors need to be aware of rules that pertain to buying and selling different series of mutual funds. Investing without understanding trailer commissions, deferred sales charges and management fees can lead to unpleasant surprises later on down the road when you want to sell units or switch between funds. Ask your advisor or the fund distributor to explain fees for the various series before you buy mutual funds.
Fund Types and Objectives Affect Your Mutual Fund Returns
In the simplified prospectus, profiles of individual funds follow the general discussion of fees and risks. Mutual fund companies normally group profiles by type, beginning with money market and bond or income funds. Asset allocation or balanced funds and pure equity or stock funds round out the list of offerings in the prospectus. The profile of each fund identifies the fund’s type, its objectives and the strategies the manager employs to meet the objectives of the fund. For example, a profile might tell you that a US value fund aims to provide superior returns by investing in domestic companies at attractive valuations in comparison to industry peers. As the fund type and the manager’s objectives will affect mutual fund returns, investors need to understand the differences between international and domestic or equity and income funds.
The Fund Profile Explains the Fund’s Investment Strategies
The objectives section of a fund profile tells you what the manager is trying to do, while the strategies section explains how the manager does it. This part of the fund profile may list the factors the manager considers when choosing stocks for the fund, as well as the fund’s limits for percentage allocations to cash, equity investments and government and corporate bonds. In addition, fund profiles typically disclose information about the portfolio turnover rate and use of derivative contracts.
Mutual Funds Investing Requires Self-Knowledge
In the simplified prospectus, each fund profile describes the ideal investor for that mutual fund. For example, the profile might say a fund is appropriate for investors with a five-year investment horizon. On the other hand, the ideal investor for a bond mutual fund might be characterized as having a lower tolerance for risk. Knowing your own limits and investment goals can help you buy mutual funds that offer reasonable rates of return without inviting drama into your life.
Understand the Indirect Costs of Investing in Mutual Funds
Each fund profile in the prospectus includes a table of expenses that investors pay indirectly to the fund. Management and administration fees are examples of embedded costs indirectly borne by investors in the fund. The table of expenses shows the estimated cost of investing $1,000 over periods of one to 10 years. As a mutual fund investor, you need to be aware that embedded costs are in addition to fees you pay directly to the fund, such as deferred sales charges and dealer commissions.
The Prospectus Won’t Always Provide Information on Mutual Fund Returns
Although investors can access performance charts for funds on a number of free financial sites, the simplified prospectus won’t always provide performance data or compound returns for the full line-up of funds. MSN Money, Google Finance and thestreet.com are good sources for information on mutual fund returns. In addition, your financial advisor can provide you with fact sheets on funds you’re considering for your investment portfolio.
As a legal document, the simplified prospectus is intended to protect prospective investors. The prospectus achieves this by disclosing information about restrictions, fees and risks associated with mutual funds. Investing without knowing your rights as an investor—including restrictions on your right to sell—can cost you a bundle in deferred sales charges and embedded fees that affect mutual fund returns.
Paula Wendland - Paula Wendland
Join the Conversation