Investing » Mutual Fund Prospectus Primer

If your attempts to examine the prospectuses and shareholder reports you get from mutual fund companies have left you cross-eyed, confused and wishing for CliffsNotes, don’t toss them into the recycle bin just yet.

Like a student who knows how to pick out just the parts of a lesson that are going to be on the test, you can extract the essential content from these documents with a little guidance and without having to digest them whole.

Federal law requires that all mutual funds provide a free prospectus and shareholder report to every current or prospective investor.

Relevant fund communications

• Know your goals, risk tolerance
• Read the investment policy
• Check out fund management
• Note fees and expenses
• Returns an important gauge
• Pay attention to turnover

• Read letter to shareholders

The prospectus describes the fund’s goals and objectives, lists the fees and expenses that are associated with the fund, explains its investment strategies and risks, and tells you how to buy and sell shares. Annual and semiannual shareholder reports give an account of the fund’s recent performance.

The prospectus describes the fund’s goals and objectives, lists the fees and expenses that are associated with the fund, explains its investment strategies and risks, and tells you how to buy and sell shares. Annual and semiannual shareholder reports give an account of the fund’s recent performance.

Know your goals, risk tolerance

A prospectus can be helpful, but it will not make much sense unless you first get a clear understanding of your investment goals.

I tell the class that I teach, ‘Before you read any prospectus, you want to know why you’re investing and what your risk tolerance is,’ says Bob Mecca, a Certified Financial Planner professional, president of Robert A. Mecca & Associates in Hoffman Estates, Illinois, and author of the e-newsletter Mecca on Mondays.

Let’s say that somebody is investing in an IRA. It’s a long-term investment of several years, and they are a moderate risk taker. When they read the prospectus, if it’s aggressive, small-cap, high-turnover, they just reject it and go to something else. You cannot read a prospectus without first understanding yourself.

When you’re ready to start poring over a prospectus, pay special attention to information about the investment policy, fund managers, fees and expenses, returns and turnover.

Read the investment policy

In describing its investment policy, a mutual fund’s prospectus will lay out the parameters in which fund managers will choose investments.

Some companies will say, ‘We can’t have more than 50 percent in junk bonds,’ or ’50 percent is going to be in U.S. Treasuries,’ Place says. Some funds will be able to invest in just about anything.

An aggressive fund manager may have wide latitude in picking companies for the fund. For example, Jim Saulnier, an independent Certified Financial Planner in Fort Collins, Colorado, recalls one real estate fund manager who expanded the definition of that category to include mining and coal companies — both part of the land, the manager reasoned. But some investors may have been surprised to learn that’s what they were getting into. Make sure you’re comfortable with what the fund has the capability of doing, Saulnier says.