Invest Wisely – A Guide To Mutual Funds


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Invest Wisely A Guide To Mutual Funds An Introduction To Mutual Funds

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 specialise 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 judgement 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 Centre, 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

Southeast Regional Office 1401 Brickell Avenue, Suite 200 Miami, FL
33131 (305) 536-5765

Atlanta District Office 3475 Lenox Road, N.E., Suite 1000 Atlanta, GA
30326-1232 (404) 842-7600

Midwest Regional Office 500 West Madison Street, Suite 1400 Chicago, IL
60661-2511 (312) 353-7390

Central Regional Office 1801 California Street, Suite 4800 Denver, CO
80202-2648 (303) 391-6800

Fort Worth District Office 801 Cherry Street, 19th Floor Fort Worth, TX
76102 (817) 334-3821

Pacific Regional Office 5670 Wilshire Boulevard, 11th Floor Los
Angeles, CA 90036-3648 (213) 965-3998

San Francisco District Office 44
Montgomery Street, Suite 1100 San Francisco, CA 94104 (415) 705-2500



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