But when it comes to picking a fund, many of us take the recommendation of friends or pick the first good fund we see - sometimes because it's so hard to read a prospectus.
CBS This Morning Money Editors Ken and Daria Dolan explain why we shouldn't throw away those unreadable documents.
The good news: The prospectus is becoming easier to read since new rules were introduced last year. It's important to look at this document and in particular, certain sections should be read before deciding whether to invest.
What kind of help is available if you do not understand the prospectus?
The Securities and Exchange Commission last year set new rules for writing these documents to make them simpler to understand. The old kind of prospectuses featured bulky pamphlets with small lettering. The new ones are thinner pamphlets with charts and graphs and less writing.
As of Dec. 1, 1999, all prospectuses will have to use everyday words, get rid of legal jargon, and have simpler sentences (ideally, no more than 15-20 words). Bullet points and bar graphs will be used to clarify how a fund is doing.
There are more than 8,000 different funds out there. You can't get 8,000 prospectuses. What do you do?
There are several wonderful sources of general mutual fund information - Money Magazine, Kiplinger's and Forbes, among others, which publish annual mutual fund surveys that classify the top funds by their objective and performance. Another good source is Morningstar.net on the Web.
You would be able to see the rankings of funds by their objectives, such as "growth and income" or "value," and obtain an 800 number to have a prospectus mailed to you.
What are the most important things to look for in a prospectus?
First, look at the sections involving investment objective and investment policies. Often, the title of the section uses words like "Goal," "Approach" or "Strategy." This section tells you whether the fund is seeking capital growth or current income or some combination. It should also describe the types of investments the fund expects to hold. Most will list a minimum/maximum percentage limitations.
The new prospectuses require a sort of laundry list of risks. If the fund is risky, you will see words like "volatile" or phrases like "above average risk."
What about those financial tables that give you the funds' performance over the last 10 years? How important are they?
Long-term performance is very important, and every prospectus has a "Financial Highlights Table." But the new prospecuses now include a bar graph so you can easily see how well the fund has done. Even better, the fund's performance must be compared to an appropriate index; for example, the S&P 500 Index. That helps to show you how well a fund is doing compared to the average.
What about fees?
You should always know the cost of an investment before you invest. One of the reasons that 90 percent of funds underperform the S&P 500 index is the fees they charge to manage your money. Since costs may vary substantially from one fund to another (even in the same group), it's important to compare fees and understand them. Fortunately, the comparison is facilitated by a fee table found in every prospectus. There are many funds with fees under 1 percent.
What else is there to watch out for?
Carefully review the "investment manager" section. Was the fund's track record achieved by the current manager? If not, why has there been a portfolio manager change? What's the experience, tenure, track record of the new manager?
For more information:
There is a free booklet, Understanding Mutual Funds, published by the Investment Company Institute, describing how to become an informed investor. You can visit the Web site at www.ici.org.
©1999 CBS Worldwide Corp. All rights reserved. This material may not be published, broadcast, rewritten, or redistributed