Mothers almost always get it right: Before you head off to school, they implore, comb your hair and tie your shoelaces.
Before going to bed, floss, bring the cat in, and flip off the lights.
That's one reason attorney Thomas Lemke was so determined to explain investing to his mother in simple, no-nonsense language.
His mother - though interested in financial issues - never showed much enthusiasm for reading a prospectus. Too difficult, she would argue. Boring. Incomprehensible!
Mr. Lemke and fellow attorney Gerald Lins decided to do something for their mothers - and all mothers and wives, not to mention husbands, friends, and other fellow mutual-fund investors.
In co-authoring a new book ("How to Read A Mutual Fund Prospectus," Mercer Point Press), they have performed a yeoman service, making it easier than ever to untangle the legalese in a fund prospectus.
And in doing so, they have underscored what should be Rule No. 1 of mutual fund investing: NEVER, EVER, INVEST IN A MUTUAL FUND WITHOUT FIRST READING THE PROSPECTUS.
The reason? According to Lemke, an attorney with Washington law firm Morgan, Lewis & Bockius LLP, the prospectus tells you everything you need to know about the fund, including who manages it, how well it has done in the past, how much it will cost you in expenses, what its objectives are, and what types of services the fund provides shareholders.
Prospectuses can be "daunting and very confusing," says Mr. Lins, a managing director and counsel with Bankers Trust, in New York. Traditionally, they have not been "fun" reads, he laughs.
Still, thanks to changes now required by the US Securities and Exchange Commission, they are far more comprehensible than in the past.
The SEC now requires simple sentences in plain English, along with standardized presentations, such as bar graphs and comparisons with known indexes including the Standard & Poor's 500 Stock Index and the Lehman Brothers Aggregate Bond Index.
There are six basic factors you need to look for when reading a prospectus, says Lemke.
Fund name: Look at a prospectus's cover page and find out what the fund name means.
Funds with descriptive names give you a better idea of its goals. Take the the T.Rowe Price International Stock Fund. Just by looking at its name, you know it invests in foreign stocks.
But other funds have generic names, such as The Vanguard Wellington Fund, or the Fidelity Magellan Fund. In such cases, you'll need to dig deeper to determine what instruments it invests in and its objectives.
Risk-return summary: It's usually listed early in the prospectus. This section shows past fund returns, and costs.
Costs are one of the main determinants of how well your investment does. Usually, the lower the cost, the higher your gain. (But not always. See story below.)
Check out all comparative charts, including the quarters of both lowest and highest returns, now required by the SEC. Ask yourself if you can handle the lowest return. If not, you might forgo that particular fund.
Financial highlights table: "This section tells you, in numbers, the history of the fund," Lemke says.
The "single most-important" measure of a fund's performance is the line of the fund's per-share financial data called "total return," he adds.Total return includes both dividends and capital gains.
Investment objectives and policies: This section tells you a fund's goals. According to Lemke and Lins, a fund seeks to do one of three things: post growth, earn income, or post growth and income. You need to see if the fund's goals mesh with your goals.
Fund management: If there is a single manager, you have to be concerned if he leaves. If that occurs, you will need to give special scrutiny to the fund to see if it maintains its objectives, Lemke says. If a committee runs the fund, there is usually less concern.
Shareholder services: This area is crucial, since it shows your "rights" as a shareholder. Example: Some funds limit the number of transfers you can make a year (such as moving your money from the fund to a money-market fund and then back again).
You also need to know how low your balance can go before charges ensue, or the fund yanks your account. Find out if you can write checks, and how you can cash out your money.
"Take at least an hour to read through a prospectus," says Lemke. If you are planning to invest in a particular type of fund (such as International funds, for example), get prospectuses from several different fund companies, line them up, and compare differences.
Why you need to read a prospectus
*The lowest-cost fund may not have the best real performance. Sometimes a fund absorbs costs to artificially boost returns. But fund managers have to tell you that in the prospectus. And they have to tell you if they plan to scrub the subsidy.
*A fund may not be "diversified" at all, which is the exact opposite of the usual reason for investing in a mutual fund. A prospectus should tell you if a fund is nondiversified.
*You invest in a tax-exempt fund to escape taxable income. Guess what? The fund might actually invest in some taxable securities, socking you with a tax bill at year-end. But the prospectus must note this.
*Shrinking assets in a fund are a cause for concern, since it may be scuttled by the fund company down the road. Check out the "net assets, end of period" line of the per share data to see if a fund's assets are heading southward. Another tip-off: an increasing expense ratio.
*Not all stock funds stay fully invested in stocks. While stock funds must have at least 65 percent of all fund assets in equities, what about the other 35 percent? Check the prospectus to find out if the rest of the money will be kept in cash or bonds. And see if the fund invests in derivatives or other risky financial instruments.
(c) Copyright 1999. The Christian Science Publishing Society