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We have learned that mutual funds are investment companies, and that they may invest in securities of various kinds, such as stocks and bonds. Money market mutual funds, which constitute a major portion of the fund universe, invest only in very short-term bonds. A fund's objective, described in the prospectus, gives broad indications of the types of investments a fund may make. The prospectus discloses important specific details about the fund that the prospective investor should be aware of, including allowable investments, expenses, risks, and financial statements. Therefore, investors should always read the prospectus carefully before investing or sending money!

How it Works. The following paragraphs will give you a more in-depth view of the contents and purpose of the prospectus. The most important aspect of a fund is its investment objective. The fund's objective tells investors the goals the fund seeks to achieve, and a good deal about how it intends to achieve them. A balanced fund will generally hold stocks and bonds. A fund seeking growth fund will utilize stocks. A fund seeking income with little or no concern for growth will generally hold bonds. The objective of a fund is so fundamental that it generally determines the category into which a fund will be assigned. For example, we speak of growth funds, foreign funds, income funds, and money-market funds. The stated objective is usually quite short, one or two paragraphs in length, and can be found in the very beginning of the fund's prospectus.

Listed below are some examples of major objective categories:

Investment Objective:

Preservation of Capital & Liquidity--Achieved by investing in very short-term bonds

Income--Achieved by investing in bonds

Balanced--Achieved by investing in bonds and stocks

Growth--Achieved by investing in stocks
Immediately following the investment objective in the prospectus is a discussion of what investments are allowed, and in what percentages. Fully diversified stock funds, for example, must conform to legal limits for maximum holdings in any one stock or industry. (Specifically, a diversified fund, as defined in the Investment Company Act of 1940, with respect to 75% of its assets, may hold no more than 5% in any one company, and not more than 10% of any firm's outstanding shares. The vast majority of mutual funds meet these conditions.) On the other end of the spectrum are sector funds, which may hold stocks from a single industry only. Risks of the various allowed investments are discussed in considerable detail in prospectuses, although it is at this point in reading the prospectus that many investors get "bogged down" in the legal verbiage and technical detail.

Although the prospectus is the investor's first line of defense, and should be examined carefully, it does not disclose everything that an investor may want to know before investing in a given fund. Further, it gives information in a way that makes comparison between funds difficult. As a result of the demand for easier-to-use and more complete information, we have witnessed a proliferation of mutual fund guides and newsletters in the past ten years. Morningstar, a relative newcomer to the fund scene, has become the dominant, independent provider of mutual fund information. They achieved their remarkable success in the market for fund information by providing comprehensive data that was previously difficult to obtain, and they did it in a manner that was timely and made comparisons of funds relatively easy. Examples of information that Morningstar and other, competitive services include are: manager's name and tenure, major individual investment holdings, overall portfolio characteristics (such as amount of stock in various industries, bond credit ratings, etc.), and performance information that is easily compared, on an apples-with-apples basis, with other funds and with indices. For example, the fund's performance will be compared on a chart with other, similar funds, and with comparable indices of similar investments (i.e., a foreign fund's performance will be compared to the performance of foreign stocks, in general). In my opinion, no mutual fund investor should be without a high-quality fund reference guide, such as Morningstar or the No-Load Fund Analyst, to supplement the basic information found in the prospectus.