Reading a Mutual Fund Prospectus

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	Prospecting for Funds Personal Finance Advisor by Deloitte & Touche OnLine May 11, 1998

Here's what to look for in a mutual fund prospectus.

More than 40 million American households own mutual funds. Investors have many alternatives -- there are approximately 8,000 mutual funds. The suitability of a particular fund will depend on the investor’s (1) objectives for the investment, (2) tolerance for price volatility, and (3) time frame for achieving financial goals. When selecting a fund, or monitoring mutual fund investments, carefully review the prospectus. Among other information, this document explains the objectives, risks, and strategies of the fund. Following is a discussion of important information included in a mutual fund prospectus.

Open-End and Closed-End Funds: In most cases, there is no limit on the number of shares that an open-end investment company (referred to as a mutual fund) can issue. Shares are issued when investors buy the fund, and redeemed when investors sell. Fund shares are issued and sold based on net asset value. Before purchasing shares, investors will be provided a copy of the fund’s prospectus. Existing fund shareholders should receive a new prospectus at least annually, or whenever the document is updated. Prospectuses are dated, and will indicate whether the fund is an open-end investment company.

Closed-end funds issue a fixed number of shares that can be traded on a stock exchange. Managed by an investment company, the proceeds from the sale of closed-end fund shares are invested in other securities. Closed-end funds usually issue a prospectus only when the shares are originally offered.

Investment Objectives: The fund’s investment objectives should be compatible with the investor’s goals. The prospectus will describe the fund’s objectives (for example, long-term capital growth, income), and the strategies used to achieve these goals. The discussion of investment strategies may describe risks (market risk, manager risk, country risk) faced by investors in the fund. The prospectus will note the types of securities (common stocks, preferred stocks, bonds, options) the fund purchases, and will identify any investment advisors employed by the fund. The document may set forth investment parameters that the fund follows (for example, limits on the use/purchase of derivatives, foreign stocks, short sales). The parameters may also indicate the maximum and minimum percentages for specific types of securities and/or holdings in any one company.

Stock mutual funds are either "actively" managed by a fund manager, or "passively" managed to match the performance of an index (for example, Standard and Poor’s 500). For actively managed funds, it is important to know the manager’s tenure and track record -- changes in a fund’s manager can have a significant impact on performance.

Portfolio Turnover: The number of times that a fund sells its security holdings during a year is the turnover rate. The statistic is usually expressed as a percentage -- a 100% turnover rate means the fund sold and replaced securities valued at 100% of its total net assets within a one-year period. For taxable investment accounts, the turnover rate will directly impact the amount of ordinary income and capital gains taxed to shareholders (the tax rate differential between ordinary income and capital gains can exceed 19%). Investors in tax-deferred retirement plans can be less concerned with turnover rate.

Fees and Expenses: The prospectus should disclose the fees and other expenses currently charged. Fund expenses are often displayed in a tabular format, and fall into two general categories -- transaction (sales) charges and operating expenses. Sales charges (load) compensate brokers, financial planners, or others, and are usually assessed as a percentage of the value of the investment. The investor can be charged either upon purchasing (front-end load) or selling (back-end load) fund shares. Many individuals prefer back-end loads because the fee often decreases the longer the investment is held. There is no definitive evidence to indicate that load funds provide a better return than no-load funds.

Operating expenses include management fees and 12b-1 fees. Management fees cover costs of research, account management, investment advisory, legal, audit, and other services. Such fees can also cover sales fees to brokers and others (referred to as level load). Charges for fund marketing and distribution costs (for example, advertising, fund literature) are 12b-1 fees. If charged, 12b-1 fees must be separately disclosed. Such fees can be assessed by both load and no-load funds.

Performance Information: The prospectus includes performance statistics (for example, average annual total returns, per share income and expense amounts, changes in net asset value). Data is often in tabular format showing figures for one, five, ten, or more years. Past performance is no guarantee of future success; however, comparing the fund’s performance statistics with relevant averages and indices can help investors assess the fund’s quality and consistency of performance over long periods of time. Short-term performance statistics are less meaningful.

New Rules: After June 1, 1998, open-end mutual funds will have the option of providing fund investors with a new disclosure document -- a "profile." Shorter than a traditional prospectus, a profile will present key information about the fund’s investment strategies, risks, performance, and fees in a standardized format. The disclosures are to be written in "plain English" -- short sentences, everyday language, active voice, no multiple negatives, no business or legal jargon, and tabular presentation of complex material. Investors who use the information in the profile to purchase mutual fund shares, will receive a traditional prospectus with the confirmation of purchase. Investors can also request the fund’s prospectus (and other information) before making an investment decision. A discussion of the new profile disclosure option (Rule 498, Release 33-7513) is available on the SEC’s web site [http://www.sec.gov/rules/final/33-7513.htm].

These are some thoughts to consider about mutual fund disclosure documents. Your financial and tax advisors can provide additional information and should be consulted before any action is taken.