The Retirement Corporation of America

How to Read a Fund Prospectus

THE FIRST THING you'll get when you want to buy a mutual fund is a prospectus—spelling out everything you need to know about that fund. The SEC recently declared that funds must begin offering investors a simplified version of a prospectus called a "fund profile" written in plain English. All funds have them now or soon will. Here's what to read:

•  The cover page or summary for warnings or special risk factors. This is where you'll find out, among other things, if a fund's annual expenses are unusually high—perhaps because its managers do a lot of short-term trading. As you just learned in this lesson, this means your taxes will also be high because the fund will pass through all those short-term gains to you, and you will have to pay taxes on them as ordinary income.

•  The section titled "Investment Objective". The mission of money market funds and bond funds is typically clearly stated: current income. The mission of a stock fund can be fuzzier but usually boils down to income, capital appreciation, or both. Know what you're buying before you buy.

•  "Investment Policies". This will tell you what kinds of securities the fund intends to buy, and if there are restrictions on the manager—that the fund must be at least 75 percent invested in government bonds at all times, for example. Here's where you'll also find out if the manager can use trading strategies that can make the fund a riskier investment, such as short selling or speculating in the futures market.

•  About fees and expenses. This spells out the costs of buying and owning the mutual fund—commission or "load," annual expenses, etc.

•  The 10-year financial table. If the fund hasn't been around that long, the table will give you its performance since inception. These figures can be confusing. Each fund gives its annual total returns—income plus capital gains—on a fiscal year basis, not by calendar year. This makes it hard to compare a fund whose fiscal year ends June 30 with another fund whose fiscal year ends March 31. The financial table will also tell you how volatile the fund's year-end share price has been over the years, how stable its dividend income has been, and the amount of "accumulated unrealized capital gains." The fund is warning you they could be realized—and become taxable to you—in the future.

•  "Management of the Fund". You want to know who the investment manager is and how much you and other shareholders are paying him or her, or increasingly, a management committee. Money market funds and funds run by committees don't have to give you their managers' names. But sometimes it will be buried in other sections, possibly in the one titled "Fund Charter". And you can always ask a sales representative who these people are and what their experience has been.

•  "Shareholder Services". Besides telling you how you can buy and sell your shares (by phone, through the mail, or even with a personal computer), this section will also tell you whether it requires a minimum investment. It will also say whether you can switch funds by phone, for example, reinvest dividends and capital gains, or buy more shares through payroll deduction or by having your Social Security check automatically deposited.

•  "Pending Legal Proceedings", if there is such a section. Occasionally, shareholders have to pay part of a fund's cost of being sued or the cost of suing someone.