INVESTING
How to Read Your Mutual Fund's Prospectus
Decision Center
..........................................
WEB LINK
Ask the Experts
..........................................
RESOURCES
The Securities and Exchange Commission requires the company to show what you would pay on a $1,000 investment assuming that it returned 5 percent a year and you redeemed the money at the end of that period. To give you a standard for comparison, consider that a fund that charges a total of 1 percent in expenses would cost $10 in one year, $32 in three years, $56 in five years and $124 in 10 years.
..........................................
GLOSSARY
EXPENSE RATIO
Expense Ratio is the percentage of a fund's assets that is paid out in expenses, which include management fees and all other fees associated with marketing, distributing and administering the fund. The average expense ratio for a domestic stock fund in 1996 was 1.43 percent, according to figures compiled by Morningstar Mutual Funds. The average expense ratio for an international fund was 1.89 percent; for a general bond fund, .94 percent; for a government bond fund, 1.1 percent and for a municipal bond, 1.0 percent.
housands of investors each year are left stewing over their mutual funds' poor performance because they didn't know how to interpret or "decode" the information offered by the mutual fund companies.
When you invest in a mutual fund, you're a shareholder of an investment company. Like a company that makes computers or shampoo, an investment company sends out reports to shareholders. For many people, the numbers and wording mean nothing. But for savvy investors, the information offers signposts for not only how things have been, but how things will be and if the fund stacks up well against its competitors.
Your mutual fund company will send you a confirmation statement each time you make a trade. File this. You'll also receive a prospectus that details how the fund will be managed. In addition you'll get annual and semi-annual reports. Spend 15 minutes with each one of them.
Look for these three things in the prospectus:
1. Expenses:
First check the transaction expenses to see what it costs to buy and sell the fund. If you're picking your own investments, you want a no-load fund. Check to make sure there's no sales load on purchases, on reinvested dividends, on redemptions or on exchanges between funds. That makes it a true no-load.
Look then at the fund's annual portfolio operating expenses. You'll see something like this:
Management fees 0.69%
12 (b) 1 fees 0.25%
Other expenses 0.57%
Total operating expenses 1.51%
That means 1.51 percent of the fund's assets will be deducted each year for expenses. Expenses are important. And the trend is upward for many funds. If a fund's expenses are above average - like the one above - you should find out why. For instance, if the fund is new, there may be substantial start-up costs.
2. Financial history:
Here you will get a snapshot of the fund's performance dating back 10 years. Check the total return year by year to see how volatile it is. Look to see how rapidly it's growing in asset size. As the fund grows, expenses should come down. For example, the prospectus for Harbor Growth Fund shows expenses in 1996 were 0.91 percent, down from 1.33 percent in 1987. That's a good sign.
Look, too, at portfolio turnover. A turnover rate of 50 percent means the manager turned over half the portfolio that year. Look for consistency. If you see a turnover rate of 61 percent one year and 187 percent the next year, you should find out why. Typically, that means the manager's investment strategy has changed or that he or she has lot faith in that strategy. Call the fund's toll-free number.
3. Investment objective:
This tells you how the manager plans to make money. For example, "the fund invests substantially all, but at least 65 percent of its assets in common stocks of companies that do business outside the United States." You'll also see what else the fund can invest in and perhaps where it's invested: "The Fund currently intends to invest primarily in Europe, the Pacific Basin and emerging industrialized countries."
If the fund invests in bonds, you should find out whether it buys only investment grade bonds or whether it buys junk bonds that offer higher rates of return, but have a much higher risk of not paying off. In that case, the prospectus might say: "The fund may invest in lower-quality bonds."
Annual reports offer insight
Now that you know what the fund sets out to do, you want to know how well it accomplishes its goals. For this, you need the annual and semi-annual reports. If your fund has been doing poorly, you'll want to know what the manager says about it.
Look for these three things:
1. The fund's annual performance compared with a performance index
If it's a large-company fund, compare it with the Standard & Poor's 500 Stock Index . If the benchmark index is not included, look it up.
2. Compare your fund with its peer groups
Compare it with reports prepared by companies like the ones compiled by Lipper Analytical Services. Expect your fund to be consistent and in the top quartile of funds in its peer group.
3. Read the portfolio manager's explanation of the fund's performance and his market outlook
This is particularly important if the fund's performance was different from that of its peer group's. Look for a candid appraisal of the market and an explanation of the fund's performance. If the fund did poorly, the manager should tell you what he expects to do about it.
Tone is important here. For example, Harold Evensky, an investment manager in Coral Gables, Fla., looks for managers with passion.
"I don't want a manager who writes a namby-pamby letter that says something like: 'We'd love to have your money and we're going to do wonderful things for you,'" Evensky says. "They should tell you if they really blew it that year and why they think they did and what they're going to do to fix it." 
How do I track the performance of my investments?
Articles
|
Next Steps
|
Illustration by Terry Allen Copyright 1998 Microsoft Corporation