Understanding Mutual Fund Prospectuses
A prospectus is a legally-required managerial disclosure of the risks of an investment registered with the Securities And Exchange Commission. All publicly-traded securities, including stocks, bonds and mutual funds must file a prospectus with the SEC, and sales representatives registered with the SEC must make the prospectus available to investors prior to taking their investments.
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Sections in a Mutual Fund Prospectus
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A mutual fund prospectus typically describes the overall objectives of the fund, the kinds of securities in which the fund will invest, information on the background of the fund management and advisors, and a discussion of the various kinds of risks associated with investing in the fund. The prospectus will also specify the expense ratio, sales charges and any other fees associated with the fund.
Fund Objectives
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Fund companies typically describe objectives in broad terms. A fund seeking capital appreciation will take risks in the hopes that the stock or bond prices will go up. A fund seeking safety of capital will avoid taking risks, preferring a conservative, risk-adverse strategy. A fund seeking current income will seek to maximize cash flow from interest payments and dividends, without taking inordinate risks. A "growth and income" fund would be a combination of the two approaches.
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Security Selection
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The prospectus will discuss how the fund selects securities. Stock funds invest primarily in equities (stocks), while bond funds or income funds will invest in bonds and other fixed-income securities, such as preferred stock. The fund may also describe its approach as "growth-oriented" or "value-oriented." Growth funds seek to maximize capital appreciation and are willing to pay a higher price per dollar of projected earnings per share for fast-growing companies; value funds tend to seek stocks that look attractive relative to the projected earnings or book value per share. The prospectus may also contain a snapshot of the fund's top 10 holdings.
Risks
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The prospectus is required to discuss all relevant, material risks associated with the fund and their investment style. Some of the major types of risk include investment risk, interest rate risk, currency risk, manager risk, inflation risk and legislative risk. Unforeseen events can cause large fluctuations in mutual fund prices, and you can lose money investing in any mutual fund.
Fees and Costs
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The prospectus will specify any fees and charges, including the expense ratio (a percentage of assets taken each year to compensate the staff and managers of the fund and to pay internal fund expenses), sales and surrender charges on various share classes and fees charged to pay for the marketing and distribution of the fund, called 12(b)1 fees.
Statutory vs. Summary Prospectus
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The statutory prospectus is the legally-required, full-length disclosure of all material information about an investment; the summary prospectus is a short form containing only the most important information about a fund.
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