Selecting a Mutual Fund
May 08, 2021
Factors to Consider When Choosing a Mutual Fund
Thinking about your long-term investment strategies and tolerance for risk can help you decide what type of fund is best suited for you. But you should also consider the effect that fees and taxes will have on your returns over time.
Degrees of Risk
All funds carry some level of risk. You may lose some or all of the money you invest â€” your principal â€” because the securities held by a fund go up and down in value. Dividend or interest payments may also fluctuate as market conditions change.
Before you invest, be sure to read a fund's prospectus and shareholder reports to learn about its investment strategy and the potential risks. Funds with higher rates of return may take risks that are beyond your comfort level and are inconsistent with your financial goals.
Some mutual funds also furnish investors with a "profile," which summarizes key information contained in the fund's prospectus, such as the fund's investment objectives, principal investment strategies, principal risks, performance, fees and expenses, after-tax returns, identity of the fund's investment adviser, investment requirements, and other information.
Statement of Additional Information ("SAI")
Also known as "Part B" of the registration statement, the SAI explains a fund's operations in greater detail than the prospectus â€” including the fund's financial statements and details about the history of the fund, fund policies on borrowing and concentration, the identity of officers, directors, and persons who control the fund, investment advisory and other services, brokerage commissions, tax matters, and performance such as yield and average annual total return information. If you ask, the fund must send you an SAI. The back cover of the fund's prospectus should contain information on how to obtain the SAI.
A mutual fund also must provide shareholders with annual and semi-annual reports within 60 days after the end of the fund's fiscal year and 60 days after the fund's fiscal mid-year. These reports contain a variety of updated financial information, a list of the fund's portfolio securities, and other information. The information in the shareholder reports will be current as of the date of the particular report (that is, the last day of the fund's fiscal year for the annual report, and the last day of the fund's fiscal mid-year for the semi-annual report).
Investors can obtain all of these documents by:
* Calling or writing to the fund (all mutual funds have toll-free telephone numbers);
* Visiting the fund's website;
* Contacting a broker that sells the fund's shares;
* Searching the SEC's EDGAR database and downloading the documents for free; or
* Contacting the SEC's Office of Public Reference by telephone at (202) 551-8090, by fax at (202) 777-1027, or by email at firstname.lastname@example.org. Please be aware that we charge $0.24 per page for photocopying.
A fund's past performance is not as important as you might think. Advertisements, rankings, and ratings often emphasize 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.
Be sure to find out how long the fund has been in existence. Newly created or small funds sometimes have excellent short-term performance records. Because these funds may invest in only a small number of stocks, a few successful stocks can have a large impact on their performance. But as these funds grow larger and increase the number of stocks they own, each stock has less impact on performance. This may make it more difficult to sustain initial results.
While past performance does not necessarily predict future returns, it can tell you how volatile (or stable) a fund has been over a period of time. Generally, the more volatile a fund, the higher the investment risk. If you'll need your money to meet a financial goal in the near-term, you probably can't afford the risk of investing in a fund with a volatile history because you will not have enough time to ride out any declines in the stock market.
Looking Beyond a Fund's Name
Don't assume that a fund called the "XYZ Stock Fund" invests only in stocks or that the "Martian High-Yield Fund" invests only in the securities of companies headquartered on the planet Mars. The SEC requires that any mutual fund with a name suggesting that it focuses on a particular type of investment must invest at least 80% of its assets in the type of investment suggested by its name. But funds can still invest up to one-fifth of their holdings in other types of securities â€” including securities that you might consider too risky or perhaps not aggressive enough.
Bank Products versus Mutual Funds
Many 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. As a result, they are not federally insured by the Federal Deposit Insurance Corporation (FDIC).
A Word About Derivatives
Derivatives are financial instruments whose performance is derived, at least in part, from the performance of an underlying asset, security, or index. Even small market movements can dramatically affect their value, sometimes in unpredictable ways.
There are many types of derivatives with many different uses. A fund's prospectus will disclose whether and how it may use derivatives. You may also want to call a fund and ask how it uses these instruments.