What You Should Know About Mutual Funds
A Message from the Secretary
Dear Investor:
There are a number of investment options available to you as a consumer.
Many people have chosen mutual funds as their primary means of investing.
Mutual funds provide professional management, diversification, convenience
and liquidity. As with all investments, mutual funds are not risk free.
It is essential that you make an informed investment decision and choose
a mutual fund which is right for you depending on your goals, investment
time frame and risk tolerance.
Many questions can arise when it comes to mutual fund investing. What
is a mutual fund? What are the different types of mutual funds? How do
I choose a fund that is right for me? What are the risks? This pamphlet
is designed to help answer these basic questions. If you have any questions
or need further assistance, please contact my office at 617-727-3548.
Sincerely,
William Francis Galvin
Secretary of the Commonwealth
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Mutual Fund Tips
- Determine your investment objectives. What is your invest ment goal:
preserving principal; generating income; paying for a child's education;
or saving for retirement? Choose a mutual fund whose objective is in
line with that goal.
- Thoroughly understand the risks associated with the mutual fund you
are considering and be sure that you are comfort able taking on those
risks.
- Read and understand all information in the fund's prospectus, Statement
of Additional Information, and, if available, its annual report. Call
the fund company or the Securities Division if you have questions regarding
these materials.
- Take the time to study the fund's fee table. Compare the fees among
various fund groups before choosing a fund. These fees are expenses
of the fund and will significantly affect your returns.
- Depending on your own investing experience, decide whether you should
invest in a fund directly or through a broker -dealer. A broker-dealer
can provide investment advice but will charge a sales load. In some
funds you can invest directly without the assistance of a broker-dealer.
These funds do not charge a sales load but do not give investment advice.
- If you are investing through a broker-dealer or utilizing the services
of a financial advisor, contact the Securities Divi sion to see if your
broker or financial advisor is registered in Massachusetts or has any
past disciplinary matters on file.
- If you are investing in a mutual fund sold at your bank or credit
union, make sure you understand that the fund is not an insured deposit
and that it is not guaranteed by the financial institution, the FDIC
or any other federal agency.
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What Is a Mutual Fund?
A mutual fund, also called an investment company, is an investment vehicle
which pools the money of many investors. The fund's manager uses the money
collected to purchase securities such as stocks and bonds. The securities
purchased are referred to as the fund's portfolio.
When you give your money to a mutual fund, you receive shares of the
fund in return. Each share represents an interest in the fund's portfolio.
The value of your mutual fund shares will rise and fall depending upon
the performance of the securi ties in the portfolio. Like a shareholder
in a corporation, you will receive a proportional share of income and
interest gener ated by the portfolio. You can receive these distributions
either in cash or as additional shares of the fund. As a shareholder,
you also have certain shareholder voting rights.
A mutual fund's portfolio is managed by a professional money manager.
The manager's business is to choose securities which are best suited for
the portfolio. Be aware, however, that even a profes sional money manager
cannot insure against a loss of principal.
The mutual fund manager will invest in many different securities. This
diversification of portfolio assets means that you as an investor have
not pinned all your hopes on one company's success. Also, because the
portfolio holds many securities, the negative impact that any one company
may have on the fund is diminished. While diversification is a benefit
of mutual fund investing, a mutual fund is still impacted, either favorably
or unfavorably, by the ups and downs of the market in general.
Mutual funds provide a relatively easy way to invest. Most funds have
a minimum investment of $1000. In addition, a mutual fund stands ready
to buy back, or redeem, your shares at any time. This liquidity allows
you to get your money when needed. There is no guarantee, however, that
your shares at the time of redemption will not have decreased in value.
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Types of Mutual Funds
The types of mutual funds vary according to the fund's investment objective.
A fund's investment objective will usually seek capital gains (gains from
the sale of portfolio securities), income (interest and dividends earned
on the portfolio securi ties) or a combination of both. While not a comprehensive
list of all mutual funds, the basic types of funds are described below.
Money Market: A money market fund seeks safety of principal by
investing in high quality, short-term securities. This type of fund is
designed with the aim that an investor's principal should not decrease
in value. There is no guarantee, how ever, that this will always be the
case. A money market fund seeks to provide a regular distribution of income
which is determined by short-term interest rates.
Growth: A growth fund invests primarily in the common stock of
well established companies. This type of fund may invest for long-term
capital gains and is not intended for an investor who seeks income.
Aggressive Growth: Like a growth fund, an aggressive growth fund
will invest primarily in common stock for long-term capital gains. An
aggressive growth fund may invest in the common stock of small companies,
out-of-favor companies or companies in new industries. It, therefore,
has a higher degree of risk than a basic growth fund.
Income: An income fund invests in either corporate, govern ment,
or municipal debt securities. A debt security is an obligation which pays
interest on a regular basis. Hence, this type of fund is designed for
investors who desire periodic income payments. There are, however, substantial
differ ences and varying degrees of risk among income funds depending
on the credit quality of the debt issuer, the maturity of the debt instrument,
and prevailing interest rates.
High Income: This category of income fund seeks to achieve a high
degree of income by investing a material portion of its portfolio in below
investment grade debt securities or junk bonds. These funds have a high
degree of risk and should be purchased by investors who can incur the
risk of loss of principal.
Balanced: A balanced fund, as the name implies, invests for both
growth and income. The fund will invest in both equity and debt securities.
A balanced fund seeks to provide long-term growth through its equity component
as well as income to be generated by the portfolio's debt securities.
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Balancing Risk with Investment Goals
Do not let anyone tell you that mutual funds are free from risk. While
risks vary depending on the fund, the potential danger is the same - loss
of principal and income. You must determine your own risk tolerance level.
This determination should be made with your investment goals in mind.
Risks that may be acceptable for a long-term investor seeking capital
appreciation may not be suitable for an investor seeking income and principal
protection. The following chart is intended to provide you with a starting
point for matching mutual fund objectives with your risk tolerance. Be
aware that not every fund designed to meet one of the stated objectives
will have a similar degree of risk. You should refer to the fund's prospectus
to determine the risks associated with a fund.
Fund Objective/Degree of Risk
Money Market/Low
Growth/Medium to High
Aggressive Growth/High
Income/Low to Medium
High Income/High
Balanced/Medium
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Disclosure Documents
The Prospectus
The fund's prospectus is one of the most important docu ments to read
when purchasing a mutual fund. It supplies the material information you
will need to make an informed invest ment decision. Information is also
available in the prospectus on certain administrative aspects of the fund,
such as buying, redeeming and exchanging shares.
The Statement of Additional Information
The SAI includes information which supplements what is disclosed in the
prospectus. A fund's audited financial statement and a list of its portfolio
holdings are included in the SAI, as well as in the annual report (see
below). Because the SAI has been legally incorporated into the prospectus,
it will be assumed that you have read it. Hence, you should always ask
for a copy and read the SAI before investing in a mutual fund. If you
encounter any problems when requesting this document, please contact the
Securities Division.
The Annual Report
The annual report is forwarded to a fund's shareholders at the end of
each fiscal year. It includes the fund's audited financial statements
and a list of the fund's portfolio securities. Unless otherwise included
in the prospectus, a fund will include in its annual report a line graph
comparing its performance to that of an appropriate broad-based securities
market index, as well as a discussion of those events, strategies and
techniques which affected its performance during the past fiscal year.
An annual report includes material information which may not be available
in other disclosure documents and, if available, should be read by a potential
investor.
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Mutual Fund Sales Charges
A mutual fund which sells its shares directly to investors without paying
sales commissions to broker-dealers is referred to as a no-load fund.
When you invest in a no-load fund your entire investment goes into buying
shares of the fund. However, because you are not paying a commission to
a broker-dealer, you will not receive financial advice.
When financial advice is needed, some investors choose a load fund. A
load fund pays a broker-dealer a sales commission. The amount you invest
in the fund is decreased by the payment of the sales commission. Some
load funds, rather than charging the sales commission at the time of the
sale, charge the fee when money is taken out of the fund. This fee is
referred to as a contingent deferred sales charge or a back-end load.
The back -end fee will usually decrease to zero the longer an investor
remains in the fund.
Another sales-related expense, which is often overlooked by investors,
is the 12b-1 fee. This fee, which is disclosed in the fund's fee table,
can be used by the fund for marketing, advertis ing or sales commissions.
Because the 12b-1 fee is a charge against the fund on an annual basis,
an investor could over the long term pay more in 12b-1 fees than would
have been permis sible as a maximum front end sales load.
Many load funds offer investors the option of paying the sales load up-front,
back-end or a combination of a reduced sales commission and a 12b-1 fee.
These sales-related options are called classes of fund shares. You should
choose the class that best matches your needs and investment time frame.
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Additional Information
If you have a problemunderstanding any aspect of your mutual fund contactthe
fund directly. Most funds have a toll- free number on the front page of
the prospectus for this purpose. There are also a number of private organizations
which publish consumer guides which address mutual funds. For more informa
tion, you may wish to contact the Investment Company Insti tute at 202-326-5872.
The Division also has a brochure to help clear up any investor misconceptions
concerning the sale of mutual funds and other investment products sold
on bank premises. You can contact the Office of the Massachusetts Secretary
of State, Securities Division for this brochure, as well as for general
information concerning your mutual fund, broker -dealer or financial advisor.
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