Advice From The U.S. Securities and Exchange Commission
TABLE OF CONTENTS
I. A MUTUAL FUND CHECKLIST II. WHY MUTUAL FUNDS? III. HOW MUTUAL FUNDS
WORK HOW TO BUY AND SELL SHARES TERMS TO KNOW HOW FUNDS CAN EARN YOU
MONEY TAXES IV. KINDS OF MUTUAL FUNDS MONEY MARKET FUNDS BOND (FIXED
INCOME) FUNDS STOCK (EQUITY) FUNDS A WORD ABOUT DERIVATIVES V. COMPARING
DIFFERENT FUNDS VIEWING PAST PERFORMANCE TIPS FOR COMPARING PERFORMANCE
COMPARING COSTS TERMS TO KNOW TIPS FOR COMPARING COSTS OTHER SOURCES OF
INFORMATION VI. IF YOU HAVE PROBLEMS OR QUESTIONS SEC OFFICES
I. A MUTUAL FUND CHECKLIST
* Mutual funds are NOT guaranteed or insured by any bank or government
agency. Even if you buy through a bank and the fund carries the bank’s
name, there is no guarantee. You can lose money. (see Part IV 'Kinds of
Mutual Funds')
* Mutual funds ALWAYS carry investment risks. Some types carry more risk
than others. (see Part IV 'Kinds of Mutual Funds')
* Understand that a higher rate of return typically involves a higher
risk of loss. (see Part IV 'Kinds of Mutual Funds')
* Past performance is not a reliable indicator of future performance.
Beware of dazzling performance claims. (see Part V 'Comparing Different
Funds')
* ALL mutual funds have costs that lower your investment returns. (see
Part V 'Comparing Different Funds')
* You can buy some mutual funds by contacting them directly. Others are
sold mainly through brokers, banks, financial planners, or insurance
agents. If you buy through these financial professionals, you generally
will pay an extra sales charge for the benefit of their advice.
* Shop around. Compare a mutual fund with others of the same type before
you buy.
October, 1994
II. WHY MUTUAL FUNDS?
Mutual funds can be a good way for people to invest in stocks, bonds,
and other securities. Why?
* Mutual funds are managed by professional money managers.
* By owning shares in a mutual fund instead of buying individual stocks
or bonds directly, your investment risk is spread out.
* Because your mutual fund buys and sells large amounts of securities at
a time, its costs are often lower than what you would pay on your own.
This document explains the basics of mutual fund investing -- how a
mutual fund works, what factors to consider before investing, and how to
avoid common pitfalls.
There are sources of information that you should consult before you
invest in mutual funds. The most important of these is the prospectus of
any fund you are considering. The prospectus is the fund’s selling
document and contains information about costs, risks, past performance,
and the fund’s investment goals. Request a prospectus from a fund, or
from a financial professional if you are using one. Read the prospectus
before you invest.
Before you buy a mutual fund, make sure it is right for you.
III. HOW MUTUAL FUNDS WORK
A mutual fund is a company that brings together money from many people
and invests it in stocks, bonds, or other securities. (The combined
holdings of stocks, bonds, or other securities and assets the fund owns
are known as its portfolio.) Each investor owns shares, which represent
a part of these holdings.
HOW TO BUY AND SELL SHARES
You can buy some mutual funds by contacting them directly. Others are
sold mainly through brokers, banks, financial planners, or insurance
agents. All mutual funds will redeem (buy back) your shares on any
business day and must send you the payment within seven days.
You can find out the value of your shares in the financial pages of
major newspapers; after the fund’s name, look for the column marked
'NAV.' TERMS TO KNOW
Net Asset Value per share (NAV): NAV is the value of one share in a
fund.
When you buy shares, you pay the current NAV per share, plus any sales
charge (also called a sales load). When you sell your shares, the fund
will pay you NAV less any other sales load (See Part V 'Comparing
Different Funds'). A fund’s NAV goes up or down daily as its holdings
change in value.
Example: You invest $1,000 in a mutual fund with an NAV of $10.00. You
will therefore own 100 shares of the fund. If the NAV drops to $9.00
(because the value of the fund’s portfolio has dropped), you will still
own 100 shares, but your investment is now worth $900. If the NAV goes
up to $11.00, your investment is worth $1,100. (This example assumes no
sales charge.)
HOW FUNDS CAN EARN YOU MONEY
You can earn money from your investment in three ways.
First, a fund may receive income in the form of dividends and interest
on the securities it owns. A fund will pay its shareholders nearly all
of the income it has earned in the form of dividends.
Second, the price of the securities a fund owns may increase. When a
fund sells a security that has increased in price, the fund has a
capital gain. At the end of the year, most funds distribute these
capital gains (minus any capital losses) to investors.
Third, if a fund does not sell but holds on to securities that have
increased in price, the value of its shares (NAV) increases. The higher
NAV reflects the higher value of your investment. If you sell your
shares, you make a profit (this also is a capital gain).
Usually funds will give you a choice: the fund can send you payment for
distributions and dividends, or you can have them reinvested in the fund
to buy more shares, often without paying an additional sales load.
TAXES
You will owe taxes on any distributions and dividends in the year you
receive them (or reinvest them). You will also owe taxes on any capital
gains you receive when you sell your shares. Keep your account
statements in order to figure out your taxes at the end of the year.
If you invest in a tax-exempt fund (such as a municipal bond fund), some
or all of your dividends will be exempt from federal (and sometimes
state and local) income tax. You will, however, owe taxes on any capital
gains.
IV. KINDS OF MUTUAL FUNDS
You take risks when you invest in any mutual fund. You may lose some or
all of the money you invest (your principal), because the securities
held by a fund go up and down in value. What you earn on your investment
also may go up or down.
Each kind of mutual fund has different risks and rewards. Generally, the
higher the potential return, the higher the risk of loss.
Before you invest, decide whether the goals and risks of any fund you
are considering are a good fit for you. To make this decision, you may
need the help of a financial adviser. There are also investment books
and services to guide you.
The three main categories of mutual funds are money market funds, bond
funds, and stock funds. There are a variety of types within each
category.
1. MONEY MARKET FUNDS have relatively low risks, compared to other
mutual funds. They are limited by law to certain high- quality,
short-term investments. Money market funds try to keep their value (NAV)
at a stable $1.00 per share, but NAV may fall below $1.00 if their
investments perform poorly. Investor losses have been rare, but they are
possible.
A WORD ABOUT BANKS AND MUTUAL FUNDS
Banks now sell mutual funds, some of which carry the bank’s name. But
mutual funds sold in banks, including money market funds, are not bank
deposits. Don’t confuse a 'money market fund' with a 'money market
deposit account.' The names are similar, but they are completely
different:
* A money market fund is a type of mutual fund. It is not guaranteed,
and comes with a prospectus.
* A money market deposit account is a bank deposit. It is guaranteed,
and comes with a Truth in Savings form.
2. BOND FUNDS (also called FIXED INCOME FUNDS) have higher risks than
money market funds, but seek to pay higher yields. Unlike money market
funds, bond funds are not restricted to high-quality or short-term
investments. Because there are many different types of bonds, bond funds
can vary dramatically in their risks and rewards.
Most bond funds have credit risk, which is the risk that companies or
other issuers whose bonds are owned by the fund may fail to pay their
debts (including the debt owed to holders of their bonds). Some funds
have little credit risk, such as those that invest in insured bonds or
U.S. Treasury bonds. But be careful: nearly all bond funds have interest
rate risk, which means that the market value of the bonds they hold will
go down when interest rates go up. Because of this, you can lose money
in any bond fund, including those that invest only in insured bonds or
Treasury bonds.
Long-term bond funds invest in bonds with longer maturities (length of
time until the final payout). The values (NAVs) of long-term bond funds
can go up or down more rapidly than those of shorter-term bond funds.
3. STOCK FUNDS (also called EQUITY FUNDS) generally involve more risk
than money market or bond funds, but they also can offer the highest
returns. A stock fund’s value (NAV) can rise and fall quickly over the
short term, but historically stocks have performed better over the long
term than other types of investments.
Not all stock funds are the same. For example, growth funds focus on
stocks that may not pay a regular dividend but have the potential for
large capital gains. Others specialize in a particular industry segment
such as technology stocks.
A WORD ABOUT DERIVATIVES
Some funds may face special risks if they invest in derivatives.
Derivatives are financial instruments whose performance is derived, at
least in part, from the performance of an underlying asset, security or
index. Their value can be affected dramatically by even small market
movements, sometimes in unpredictable ways.
There are many types of derivatives with many different uses. They do
not necessarily increase risk, and may in fact reduce risk. A fund’s
prospectus will disclose how it may use derivatives. You may also want
to call a fund and ask how it uses these instruments.
V. COMPARING DIFFERENT FUNDS
Once you identify the types of funds that interest you, it is time to
look at particular funds in those categories.
VIEWING PAST PERFORMANCE
A fund’s past performance is not as important as you might think.
Advertisements, rankings, and ratings tell you how well a fund has
performed in the past. But studies show that the future is often
different. This year’s 'number one' fund can easily become next year’s
below average fund. (NOTE: Although past performance is not a reliable
indicator of future performance, volatility of past returns is a good
indicator of a fund’s future volatility.)
TIPS FOR COMPARING PERFORMANCE
* Check the fund’s total return. You will find it in the Financial
Highlights, near the front of the prospectus. Total return measures
increases and decreases in the value of your investment over time, after
subtracting costs.
* See how total return has varied over the years. The Financial
Highlights in the prospectus show yearly total return for the most
recent 10-year period. An impressive 10-year total return may be based
on one spectacular year followed by many average years. Looking at
year-to-year changes in total return is a good way to see how stable the
fund’s returns have been.
COMPARING COSTS
Costs are important because they lower your returns. A fund that has a
sales load and high expenses will have to perform better than a low-cost
fund, just to stay even with the low-cost fund.
Find the fee table near the front of the fund’s prospectus, where the
fund’s costs are laid out. You can use the fee table to compare the
costs of different funds.
The fee table breaks costs into two main categories:
1. sales loads and transaction fees (paid when you buy, sell, or
exchange your shares), and
2. ongoing expenses (paid while you remain invested in the fund).
Sales Loads
The first part of the fee table will tell you if the fund charges any
sales loads.
No-load funds do not charge sales loads. When you buy no-load funds, you
make your own choices, without the assistance of a financial
professional. There are no-load funds in every major fund category. Even
no-load funds have ongoing expenses, however, such as management fees.
When a mutual fund charges a sales load, it usually pays for commissions
to people who sell the fund’s shares to you, as well as other marketing
costs. Sales loads buy you a broker’s services and advice; they do not
assure superior performance. In fact, funds that charge sales loads have
not performed better on average (ignoring the loads) than those that do
not charge sales loads.
TERMS TO KNOW
Front-end load: A front-end load is a sales charge you pay when you buy
shares. This type of load, which by law cannot be higher than 8.5% of
your investment, reduces the amount of your investment in the fund.
Example: If you have $1,000 to invest in a mutual fund with a 5%
front-end load, $50 will go to pay the sales charge, and $950 will be
invested in the fund.
Back-end load: A back-end load (also called a deferred load) is a sales
charge you pay when you sell your shares. It usually starts out at 5% or
6% for the first year and gets smaller each year after that until it
reaches zero (say, in year six or seven of your investment).
Example: You invest $1,000 in a mutual fund with a 6% back-end load that
decreases to zero in the seventh year. Let’s assume for the purpose of
this example that the value of your investment remains at $1,000 for
seven years. If you sell your shares during the first year, you only
will get back $940 (ignoring any gains or losses). $60 will go to pay
the sales charge. If you sell your shares during the seventh year, you
will get back $1,000.
Ongoing Expenses
The second part of the fee table tells you the kinds of ongoing expenses
you will pay while you remain invested in the fund. The table shows
expenses as a percentage of the fund’s assets, generally for the most
recent fiscal year. Here, the table will tell you the management fee
(which pays for managing the fund’s portfolio), along with any other
fees and expenses.
High expenses do not assure superior performance. Higher expense funds
do not, on average, perform better than lower expense funds. But there
may be circumstances in which you decide it is appropriate for you to
pay higher expenses. For example, you can expect to pay higher expenses
for certain types of funds that require extra work by its managers, such
as international stock funds, which require sophisticated research. You
may also pay higher expenses for funds that provide special services,
like toll-free telephone numbers, check-writing and automatic investment
programs.
A difference in expenses that may look small to you can make a big
difference in the value of your investment over time.
Example: Say you invest $1,000 in a fund. Let’s assume for the purpose
of this example that you receive a flat rate of return of 5% before
expenses. If the fund has expenses of 1.5%, after 20 years you would end
up with roughly $1,990. If the fund has expenses of 0.5%, you would end
up with more than $2,410. This is a 22% difference.
TERMS TO KNOW
Rule 12b-1 fee: One type of ongoing fee that is taken out of fund assets
has come to be known as a rule 12b-1 fee. It most often is used to pay
commissions to brokers and other salespersons, and occasionally to pay
for advertising and other costs of promoting the fund to investors. It
usually is between 0.25% and 1.00% of assets annually.
Funds with back-end loads usually have higher rule 12b-1 fees. If you
are considering whether to pay a front-end load or a back- end load,
think about how long you plan to stay in a fund. If you plan to stay in
for six years or more, a front-end load may cost less than a back-end
load. Even if your back-end load has fallen to zero, over time you could
pay more in rule 12b-1 fees than if you paid a front-end load.
TIPS FOR COMPARING COSTS
* Beware of a salesperson who tells you, 'This is just like a no-load
fund.' Even if there is no front-end load, check the fee table in the
prospectus to see what other loads or fees you may have to pay.
* Check the fee table to see if any part of a fund’s fees or expenses
has been waived. If so, the fees and expenses may increase suddenly when
the waiver ends (the part of the prospectus after the fee table will
tell you by how much).
* Many funds allow you to exchange your shares for shares of another
fund managed by the same adviser. The first part of the fee table will
tell you if there is any exchange fee.
Shop wisely. Compare fees and expenses before you invest.
V. OTHER SOURCES OF INFORMATION
Read the sections of the prospectus that discuss the risks, investment
goals, and investment policies of any fund that you are considering.
Funds of the same type can have significantly different risks,
objectives and policies.
All mutual funds must prepare a Statement of Additional Information (SAI,
also called Part B of the prospectus). It explains a fund’s operations
in greater detail than the prospectus. If you ask, the fund must send
you an SAI.
You can get a clearer picture of a fund’s investment goals and policies
by reading its annual and semi-annual reports to shareholders. If you
ask, the fund will send you these reports.
You can also research funds at most libraries. Helpful resources include
fund investment books, investor magazines and newspapers. The fund
companies themselves can also provide information.
VI. IF YOU HAVE PROBLEMS OR QUESTIONS
If you encounter a problem or have a question concerning a mutual fund
that you believe can be addressed by the SEC, contact an SEC consumer
specialist at one of the offices listed on the next page.
Remember: There are no guarantees in mutual fund investing. Inform
yourself and exercise your judgment carefully before you invest.
SEC OFFICES
U.S. Securities and Exchange Commission Headquarters Office of Consumer
Affairs 450 Fifth Street, N.W. Washington, D.C. 20549. (202) 942-7040.
Northeast Regional Office 7 World Trade Center, Suite 1300 New York, NY
10048 (212) 748-8000
Boston District Office 73 Tremont Street, Suite 600 Boston, MA
02108-3912 (617) 424-5900
Philadelphia District Office 601 Walnut Street, Suite 1005 E
Philadelphia, PA 19106-3322 (215) 597-3100
Finances
