Course 108: Important Fund Documents, Part 1
The Prospectus
In this course
1 Introduction
2 The Prospectus
3 Statement of Additional Information

The prospectus tells you how to open an account (including minimum-investment requirements), how to purchase or redeem shares, and how to contact shareholder services.

It also details six aspects of the fund that you need to know about before you decide to buy shares.

1. Investment Objective.The investment objective is the mutual fund's purpose. Is the fund seeking to make money over a long-term period? Or is it trying to provide its shareholders regular income each month? If you're investing for your young child's education, you'll want the former. If you're looking for a monthly dividend check, you'll want the latter. But investment objectives are often vague. That's why you'll want to check out the next section.

2. Strategy.The prospectus also describes the types of stocks, bonds, or other securities in which the fund plans to invest. (It does not list the exact stocks that the fund owns, though.) Stock funds spell out what kinds of companies they look for, such as small, fast-growing firms or big, well-established corporations. Bond funds specify what sorts of bonds they generally hold, such as Treasury or corporate bonds. If the fund can invest in foreign securities, the prospectus says so. Most (but not all) restrictions placed on the fund are also mentioned here, including references to short selling, leveraged purchases, and so on.

3. Risks.This section may be the most important part of the prospectus, but it's generally written in very broad language. Every investment has risks associated with it, and a prospectus must explain these risks. For instance, a prospectus for a fund that invests in emerging markets will reveal that the fund is likely to be riskier than a fund that invests in developed countries. Bond-fund prospectuses typically discuss the credit quality of the bonds in the fund's portfolio, as well as how a change in interest rates might affect the value of its holdings.

4. Expenses.It costs money to invest in a mutual fund, and different funds have different fees. A table at the front of every prospectus makes it easy to compare the cost of one fund with another. Here, you'll find the sales commission the fund charges, if any, for buying or selling shares. The prospectus also tells you, in percentage terms, the amount deducted from the fund's return each year to pay for things such as management fees and operational costs.

5. Past Performance.We all know the fund world's catch-all phrase: "Past performance is no guarantee of future results." But a fund's record can give you an idea of how consistent its performance has been. A chart known as the "Financial Highlights" or "Per-Share Data Table" provides the fund's total return for each of the past 10 years, along with some other useful information. It also breaks out the fund's income distributions and provides the year-end NAV.

Some prospectuses include additional return information in the form of a bar chart, which illustrates the fund's calendar-year returns for the past 10 years. This chart is a good way to get a handle on the magnitude of a fund's ups and downs over time. The prospectus may also use a growth of $10,000 graph (also known as a mountain graph, because the peaks and valleys resemble the cross section of a mountain) or a table comparing the fund's performance to indexes or other benchmarks to present return information. (Unless otherwise stated, total return numbers do not take sales charges into account, but they do take into account a fund's annual expense ratio.)

6. Management. The Management section profiles the folks who will be putting your money to work. As of March 2005 funds are required to list all of their team members in their prospectuses. Considerthe fund manager's tenure if it's relatively short, the fund's past record may have been achieved under someone else. Find out whether the manager has run other funds in the past. A peek at those funds could give you some clues about the manager's investment style and past success.

Next: Statement of Additional Information >>


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