This article is from the Investing Articles: Mutual Funds series.
Mutual funds are no different than any other investment; before you invest, you must know invest your own investment goals and objectives. Two of the biggest mistakes people make are failing to match their goals with the fund's goals, and failing to inquire into the performance and reputation of the fund and its manager. Before you choose a fund, establish your own financial goals, decide how much risk you can afford to take and consider the cost, services and track record of the mutual fund.
It is important to obtain and read the fund's prospectus. A prospectus is a document given to potential investors in connection with a public offering of securities. It is a written statement of all relevant information about the company, such as its history, operations, financial conditions and key personnel. Mutual funds are required by law to provide prospectuses. Most include a description of the general nature of the fund, a summary of the financial structure and operation, description of fund assets, the management structure, salaries of officers, the expenses of the offering, specific uses of the proceeds, and current lawsuits against the issuer.
The prospectus also contains the investment objectives of the fund. The success of the fund is measured by how well the fund achieves its stated objectives. Some of the most common objectives are "conservation of capital," "growth" or "steady income." Your decision to purchase shares of a mutual fund should begin with a careful examination of its investment objectives. The company's objectives should correspond with your own objectives and ability to tolerate the risk associated with those objectives. Every fund's prospectus is now also required to disclose all fees. The prospectus must show what the fees would be for a hypothetical investment of $1000 over one, three, five- and ten-years. Funds must also follow a standardized formula in computing their advertised performance data. All funds that advertise performance must include one- five- and ten-year averages of annual total return. In their advertisements, the funds must also explain that the data is historical and is not a prediction of future performance. An investor's shares can be worth less upon redemption than when they were bought.
In addition to the prospectus, the fund will send you, upon request, a statement of additional information (SAI). This "SAI" is a detailed document that explains the financial workings of the fund and provides disclosure about the backgrounds and expertise of individuals and companies involved in managing and marketing the fund. If, after you read the prospectus, you want more information, request a copy of the SAI. If you still have questions, go over the proposed investment with the broker. Remember that this is a service you pay for with your sales charge, so take advantage of the fact that you have a professional at hand who understands the investment and can explain it to you.
The Securities Division registers mutual funds and licenses the people who sell them. Before you invest, be sure that the fund you have selected and the person selling you the fund are properly registered with the Division. Although registration is no guarantee against loss, it does assure that certain minimum standards have been met.