from the Securities and Exchange Commission
The SEC’s Office of Investor Education and Advocacy is issuing this Investor Bulletin to help inform investors about key information in a prospectus. You should note, however, that a prospectus contains additional information that may assist investors in making an investment decision.
Introduction
Mutual funds use a document called a prospectus to disclose information about the fund to investors. The SEC requires mutual funds to include important information in the prospectus, including:
the fund’s investment objectives or goals;
its strategies for reaching those goals;
the principal risks of investing in the fund;
the fund’s fees and expenses; and
its past performance.
SEC rules require mutual funds to provide a copy of the fund’s prospectus before or with the delivery of fund shares to investors, but you can – and should – also request and read a prospectus before making an investment decision. You can obtain prospectuses from the SEC’s Electronic Data Gathering, Analysis, and Retrieval (“EDGAR”) database or directly from the fund (most funds provide their prospectus on their websites and also have toll free numbers where you can request a copy). Funds also may provide a “summary prospectus,” which is generally just a few pages long, but indicates where you can obtain the full prospectus.
Investment Objective
The investment objective of a fund frequently will be: (1) capital appreciation; (2) income; or (3) a combination of the two.
Funds that seek capital appreciation primarily invest in assets the fund expects to increase in value.
Funds that seek income primarily invest in securities that produce income, such as bonds that pay interest or securities that pay dividends.
Funds that seek a combination of growth and income generally invest in equity securities that pay dividends or else invest in a mix of equity securities and bonds.
Generally, funds that seek capital appreciation are considered a more aggressive investment strategy (i.e., have the potential for greater returns, but also the possibility of greater losses), while funds that seek income are considered a more conservative investment strategy.
Principal Strategies
The principal strategies of the fund tell you how the fund intends to achieve its investment objective. These strategies indicate the approach the fund’s adviser takes in deciding which securities to buy or sell. For example, the fund may choose to concentrate in one or more industries, geographic regions, or types of securities. In addition, some funds may be actively managed while others seek to replicate the performance of a specified index. Although a fund’s name often suggests that the fund focuses on a particular type of investment, you should not rely upon the fund’s name without examining the prospectus further.
Some funds may also reserve the right to take a “temporary defensive position.” These funds may invest 100% of assets temporarily in cash or other relatively safe instruments in anticipation of a market downturn that could adversely affect fund performance, even if that would not normally be consistent with the fund’s primary investment strategy.
Risks
All investments in funds involve risk of financial loss. The reward for taking on risk is the potential for a greater investment return. An investor with a high-risk tolerance is generally willing to risk losing money in order to seek larger investment gains than those typically achieved by a lower-risk investment. On the other hand, an investor with a low-risk tolerance may favor investments in funds that are generally more stable in value.
When reading a fund prospectus, it is important to determine if the fund satisfies your investment objective and matches your risk tolerance, as well as the risks in your overall portfolio. Your risk tolerance depends upon several factors, including your financial situation, age, and family obligations.
The types of risks to which a fund is subject vary considerably with the nature of its investments. Some of the more common risks for funds include:
Market risk. The fund may incur losses due to declines in the markets in which it invests.
Business or Issuer risk. The fund may invest in a company that goes out of business, suffers financial problems, or otherwise does not perform as expected, especially if the fund primarily invests in companies without an established record.
Credit risk. The fund may invest in bonds or other debt instruments from an issuer who is unable to pay interest payments as scheduled or repay the principal.
Interest rate risk. The value of the fund’s investments in bonds or other debt instruments may decrease if interest rates rise.
Inflation risk. The value of the fund’s investments in bonds or other debt instruments also may not keep track with price increases from inflation.
Concentration risk. The fund may concentrate its investments in a particular industry, sector or geographical area, which can result in a less diversified portfolio that may be subject to greater volatility in performance than a fund that does not concentrate its investments.
Fee Table
When you consider investing in a fund, its fees and expenses are an important factor to consider. A fund with high costs must have higher investment returns than a low-cost fund to generate the same returns for you. Even small differences in fees can add up to substantial differences in your investment returns over time. Prospectuses are required to present fees and expenses in a standardized format to help investors more easily compare them across different funds.
The prospectus will include: (1) shareholder transaction expenses, which are charges you pay directly, such as sales charges that might be charged when you buy and sell shares in the fund; (2) annual fund operating expenses, which are ongoing charges that are paid by the fund but that you pay indirectly each year you are invested in the fund; and (3) a hypothetical example that shows the estimated expenses that you will pay for investing in the fund over different time periods.
Shareholder transaction expenses include sales charges (also known as “loads” or “commissions”), which are generally paid to the investment professionals who sold the fund to you to compensate them for their services. You can also purchase shares of certain funds without sales charges directly from those funds (“no-load” funds) without the assistance of an investment professional. Shareholder transaction expenses can also include additional costs, such as account maintenance fees that may be charged if the size of your investment drops below a minimum amount.
Annual fund operating expenses are frequently referred to as the “expense ratio,” because they indicate the percentage of net assets that are used by the fund each year to pay for fees and expenses. These fees and expenses include management fees, “rule 12b-1” fees, and other expenses. Management fees are paid to compensate the investment adviser for determining what securities the fund should invest in and providing related services. “Rule 12b-1” fees are paid out of fund assets for marketing and sales costs. Other expenses include miscellaneous expenses such as auditing, legal, custodial, and transfer agency fees. Funds may also temporarily waive (or stop charging) some of these fees to attract or maintain investors , although these fees may be charged again or recouped in the future.
The hypothetical example will show the estimated cost of owning the fund in actual dollar amounts (instead of in percentages) based on a hypothetical investment of $10,000 over the course of one, three, five and ten years, both where the investor redeems his or her shares at the end of those periods or instead holds those shares through those periods. The hypothetical example reflects both the operating and shareholder transaction expenses you will pay and illustrates how minimizing those expenses can help maximize the rate of return from your investments.
Funds will often offer different share classes that invest in the same “pool” or investment portfolio of securities but have different sales charges and operating expenses. For example, class A shares might have a 4% front-end sales load but no ongoing rule 12b-1 fees, and thus might be a good fit for a “buy and hold” investor who plans to remain invested for many years until retirement. In contrast, class C shares might have no front-end sales load but instead have a 1% annual rule 12b-1 fee, and thus be a better fit for a short-term investor who plans to sell quickly (in this case, within four years of purchase). Consider your personal situation when deciding which share class is right for you.
For more information about fees and expenses, including a chart showing how different fees and expenses would affect a hypothetical investment of $100,000 over 20 years and information about front end sales loads, deferred sales loads, and redemption fees, please refer to Investor Bulletin: Mutual Fund Fees and Expenses.
Performance
When you consider investing in a fund, its investment performance is another factor to consider. However, past performance is no guarantee of future results.
The prospectus will include: (1) a bar chart displaying the fund’s investment performance for the past ten years (or since the fund’s creation if the fund has less than ten years of performance history); (2) a table comparing the fund’s performance over the past ten years relative to a broad-based securities market index; and (3) the fund’s performance for its best and worst calendar quarters.
The bar chart will depict the fund’s historic performance, and will demonstrate how consistent (or not) the fund’s returns have been.
The table will compare the performance of the fund to that of the broader market (as represented by a market index). In some cases, the fund will also include a comparison to a more narrowly based index the fund believes serve as a better benchmark for comparative purposes.
The fund’s performance for its best and worst calendar quarters indicates how volatile its returns have been.
Management
The management of the fund is an important element in determining its investment success. The prospectus will describe: (1) the investment adviser (and any sub-advisers the investment adviser may hire) and (2) the individual portfolio manager(s) employed by the investment adviser.
The investment adviser (also known as the “investment manager” or “management company”) is generally the company that provides portfolio management services to the fund. The investment adviser manages the fund’s investments according to the fund’s investment objectives and investment policies. In return for these services, the fund pays the investment adviser an investment advisory or management fee, which is a component of the fund’s expense ratio. Some funds may also have a sub-adviser to manage investments for all or part of the portfolio or for all investment decisions relating to a certain type of investment (such as international equities).
The portfolio managers are the individuals who work for the investment adviser and make the day-to-day decisions about what investments to buy and sell. The prospectus generally will provide you with the name(s) of the portfolio managers and additional information such as their current title, prior work experience, and length of time with the fund. You should consider the potential effect of changes in portfolio managers when reviewing a fund’s past performance.
Shareholder Information
The prospectus will contain other information for shareholders, including information about: (1) buying and selling fund shares; (2) distributing dividends; (3) and exchanging shares between funds.
Buying and selling shares. Typically, funds will permit investors to buy and sell shares by check, wire transfer, or telephone, or by contacting a broker. Purchases and redemptions are made at the net asset value next calculated by the fund, in other words, the next net asset value per share that is calculated after receiving your order. A fund’s net asset value per share is the market value of the fund’s assets, minus fund expenses and any other liabilities, divided by the number of fund shares outstanding. Many funds calculate net asset value per share each business day at 4 pm Eastern Standard Time, which is generally when the New York Stock Exchange closes. Funds are required to pay redemptions within seven calendar days, but some funds pay redemptions within one or two business days. Some funds may also have minimum investment amounts to open an account or account balance minimums that shareholders must maintain to avoid paying account maintenance fees or having their account closed. Many funds will allow you to automatically invest in the fund by having money transferred regularly from your bank account to the fund.
Dividend distributions. Typically, funds will offer several options for payments of dividends from the fund’s portfolio holdings. For example, many funds will allow investors to withdraw their dividends (typically by having dividends deposited in a bank account) or to automatically reinvest the dividends in the fund.
Fund family exchanges. Many funds are offered within a family of funds and you may be able to exchange your shares in a fund with shares of another fund in the same fund family. In this case, exchanges can often be made with a telephone call or by providing instructions online, instead of having to fill out paperwork as would normally be required. An exchange might be subject to a small fee, and may require you to pay taxes.
Statement of Additional Information
Although the prospectus provides much information needed to make an informed investment decision, the statement of additional information (“SAI”) provides more detailed disclosures if you want more information. The SAI generally includes information about: (1) the history and description of the fund; (2) fund officers and directors; and (3) other topics.
The fund description will include information about the fund’s investment strategies and policies (for example, policies on borrowing and making loans and policies that the fund considers “fundamental”). Fundamental policies may not be changed without shareholder approval, and may include the fund’s investment objective.
The disclosure about fund officers and directors will include their names, positions, length of service to the fund, and work history for the past five years. It will also describe the leadership structure of the board and the amount of equity securities owned by each director in the fund and in funds in the fund family that are overseen by that director.
Other disclosures include information about service providers (including the investment adviser and underwriter), brokerage commissions, tax matters, and financial statements.
Funds must provide you the SAI without charge if you request it. You can obtain an SAI by calling the toll-free number that appears on the back cover page of the prospectus, or by searching the SEC’s Electronic Data Gathering, Analysis, and Retrieval (“EDGAR”) database.
Conclusion
Mutual fund prospectuses provide you with important information so you understand how the fund works and can easily compare it with other funds. If you wish to make an informed investment decision, you should read the prospectus before buying or selling shares in a mutual fund. If you would like additional information, you can obtain an SAI free of charge from the fund or from the SEC’s EDGAR database.
Related Information
For additional educational information for investors, see the SEC’s Investor.gov website or the Office of Investor Education and Advocacy’s homepage.
The Office of Investor Education and Advocacy has provided this information as a service to investors. It is neither a legal interpretation nor a statement of SEC policy. If you have questions concerning the meaning or application of a particular law or rule, please consult with an attorney who specializes in securities law.
