What to Look for in a Mutual Fund Prospectus

Battling your way through a mutual fund prospectus is probably the most difficult part of investing in mutual funds.

A prospectus is a legal document that goes through all the basics about the fund--what it costs, what it returns, who manages the money, what they do with it, how much money there is and other pertinent facts. The information is vital to any investor.

But is the presentation clear? Concise? Readable? Not necessarily.

Reading a prospectus is an investor’s penance. It’s unpleasant. But afterward, you can face the world with a clear conscience and a relatively strong conviction that what you decided was right.

And once you know what to look for, the job doesn’t have to be onerous. Mutual fund experts suggest that you start by looking at the simplest things in an effort to cut the time required to read one of the documents.

* Check the name of the fund and the date. Prospectuses need to be updated at least once a year. If you have an old report, it will not include recent performance, management changes or changes in the fund’s investment philosophy. In short, last year’s prospectus is trash. Don’t allow a salesman to persuade you otherwise.

* Look for minimum investment limitations. Many mutual funds require you to invest a specified amount to start. If the minimum investment is too rich for you, you can eliminate this fund without looking further.

* Check to make sure the fund’s investment objectives mesh with your own. If you are looking for current income, make sure the fund says that generating high current income is one of its primary goals.

To some extent, you should know what the fund’s objectives are before you request the prospectus. But fund goals sometimes change, so it’s advisable to read through this section regardless.

* Read carefully the section titled “risks.” This should be near the front, but it may be slightly disguised. One fund prospectus, for example, has risks under the heading “Certain securities and investment techniques.”

This section should spell out reasonably clearly whether the fund is taking risks you can stomach. If you don’t understand the risks or the risks make you uncomfortable, invest in a different fund.

* Consider the fund’s investment practices. Some funds always hold a portion of their assets in cash or other investments. They do this either to fulfill their investment objectives or to safeguard a certain amount of principal. This can be good or bad. For example, if you’re in a stock market fund that always has a certain cash reserve, the fund would probably earn less than the market when the market is booming but lose less when it’s sour.

Meanwhile, other funds say they’ll invest a large portion of their assets in the securities or debt of certain types of companies. For example, 70% of a fund’s assets may have to be invested in biotechnology stocks. That restriction forces the manager to invest regardless of whether he or she believes that biotechnology stocks are good or bad buys.

Investment practices can determine whether your fund is more stable or more volatile than the average.

* Look for consumer services and options. Most funds have a variety of bells and whistles that may or may not be important to you. If you want check-writing privileges with your money market fund, you should make sure it’s offered and it’s not too limited. Some money market funds won’t allow you to write checks under $1,000, for example.

Additionally, the fund should disclose how you can transfer money between accounts, whether they’ll cut the sales charges if you intend to invest a specified amount and if you can reinvest your earnings without incurring a sales charge.

* Your last step is to look at the performance tables and fees. These are almost always right in the front of the prospectus and are generally the easiest parts to read.

First look at performance. Things you should consider here include whether the fund’s performance is relatively consistent or if it swings wildly year-to-year.

You should compare to see how similar funds have performed over the same period. (If you are checking out several funds that suit your investment objectives, this should be easy. Just open each to the performance page and compare. If you have access to Morningstar Inc.’s performance reports, however, you can get a wider sampling analyzed by experts.)

Finally, check out the fees. They’ll be next to the statement of performance. You want to determine whether the fees are in keeping with industry standards and whether paying them will significantly affect your overall return.