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How to read a mutual fund prospectus

Kyle Tetting shows how investors can use a mutual fund prospectus to learn about the fund’s objectives and key investment strategies, performance, fees and more. Kyle spoke with Joel Dresang in a Money Talk Video. A transcript of their discussion is below.

Joel Dresang: Kyle, investors are required to receive a prospectus for each mutual fund that they invest in. Broadly, explain for us what a prospectus is.

Kyle Tetting: The importance of the prospectus for investors is that it really outlines what a fund is trying to do – what its objectives are, what kind of risks to expect. So, broadly speaking, it’s that document that really is going to tell you what it is you have.

Joel: Now, show us some of the things that investors should be looking at, and as an example, let’s look at Intermediate Bond Fund of America.

Kyle: Sure, for the Intermediate Bond Fund of America, first and foremost what we’re looking at is the investment objective – the very top thing, the very first thing that’s listed in the prospectus.

It’s important to know what the fund is trying to accomplish. And for this particular fund, they’re looking for income that’s consistent with capital appreciation and also consistent with some of the other things that they lay out in the prospectus – particular maturities that they’re looking for, particular credit quality that they’re looking for.

So really, you get an understanding of, “Okay, this is why I’m investing in the Intermediate Bond Fund.”

Joel: And it also lays out expenses expected?

Kyle: So you’ve got a whole section just devoted to what are the expenses of the various share classes that you may invest in. And that’s a conversation, really, that you want to have with an advisor: Which share class is appropriate? But, ultimately, you can get an idea for what those costs are, regardless of what it is you’re investing in.

They also do a really nice job of saying, “In a hypothetical investment of $10,000, what would this cost me over one year, three years, five years, 10 years?”

Joel: And, besides the expenses and the overall objective, they discuss strategies in there.

Kyle:  Yeah, the principal investment strategies. What are we doing in order to accomplish that investment objective that we talked about? So really, what you’re looking at is for the Intermediate Bond Fund – for example – a fund that is focused on single-A or better investment-grade type bonds.

It’s important to remember also that they’re looking for a specific maturity, that intermediate-term range, so somewhere between three and five years. And ultimately, that really drives the decision-making of the portfolio. They’re really limiting themselves to a very particular strategy: That intermediate-term bond space.

Joel: They also lay out the risks.

Kyle: So, it’s really important to understand that that risk section is a bit wordy. It’s written for lawyers by lawyers, but you do get an idea of what kinds of things you should expect as far as market-specific risk, company-specific risk and some of the other risks that are associated with investing in some more complex derivative-type products which do exist – in this particular fund as well as a number of other fixed-income funds.

Joel: There’s a section in there for investment results, but we always warn that past results are no guarantee of future performance.

Kyle: That’s right Joel. It’s so important to remember that no matter what you see as far as that historical performance, there’s no guarantee that that’s what you’re going to get. However, I do think it’s important to note that you’ve got those range of returns laid out there.

So, how have we done from year to year? How have we done from quarter to quarter? You can see. There’s the lowest quarter, the highest quarter reported. So you can get an understanding of, “Okay, what should I expect? What’s a typical range of returns for this portfolio?”

Joel: So we’ve been looking at a summary prospectus. There’s also a statutory prospectus, which is more detailed, more technical language. As you say, it’s lawyers writing for lawyers.

Kyle:  It’s available to investors if they really want to dig through the weeds and get an understanding of everything that’s out there. But, importantly, that summary prospectus is going to have the basics for what an investor would need to know to invest in a fund.

But I think it’s also important to remember it’s not just those prospectuses. There’s also a fact sheet, which is a little bit more current, a little bit more detailed information on how a fund is invested. There’s also annual reports and semi-annual reports that are mailed, which give you a little more insight into what management is thinking and why they’re making the choices they’re making with the fund.

Joel: So, bottom line, at a minimum, what should investors be doing with all this information they can get?

Kyle: It’s important to have conversations with their advisor about what it is that they’re investing in. Part of that is reading through that, that, uh, primary objective of the fund to get an understanding of what they’re trying to do.

But once they’ve got an understanding of what they have, then it’s just a matter of putting it in the file so if they ever have a question later, they can pull it out and say, “Okay, this is what the manager was supposed to be doing.”

Kyle Tetting is director of research at Landaas & Company.

Joel Dresang is vice president-communications at Landaas & Company.

Money Talk Video by Jason Scuglik

(initially posted Dec. 18, 2015)

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