The Securities and Exchange Commission regulates mutual fund companies and the requirement that they send annual reports to all shareholders. Much of an annual report includes legal language and data that an investor may not even read, but that are necessary to fulfill SEC requirements. A few sections are key to understanding what's really happening under the hood at your mutual fund and whether you should start shopping for a new investment.
Fund Objective and Strategy
Each fund is required to state a summary of its investment strategy. Some funds purchase small-company stocks, municipal bonds or technology stocks, while others tout their green philosophy or socially responsible investments. This doesn't include what specific investments they hold, but it's a summary of what to expect, and may indicate asset allocation targets, or maximum or minimum holdings in specific sectors or countries. Compare the strategy to the actual portfolio holdings and evaluate whether a fund has diverged from its goals.
This section shows how well the fund did during the past year. It's not only important to see whether you're making money or losing it, but also to see how your fund compared to the others of the same class, and how it compared to the standard investment indexes, called benchmarks. If a small-cap fund compares itself an international index, the comparison isn't useful. Check that any comparative returns are to similar fund classes or you're looking at apples and oranges. The SEC requires a statement from the fund manager regarding performance. It can help you decide whether explanations regarding poor performance make sense or whether it's time to switch funds.
The report must show how many shares the fund holds of everything in its portfolio, in both list and graphic form -- often a pie chart. Check to see what they are buying or selling and whether this matches up with both the stated fund objective and your own investment goals. Watch for high concentrations of individual stocks, sectors or countries in funds that are supposed to be diversified, holding a wide variety of investments.
The SEC requires each fund to list the expenses associated with a $1,000 investment in the fund. Compare these to funds of the same type. Index fund costs are lower than funds that cherry-pick their investments, due to relative costs of research and staff. Related to expenses is the fund's turnover ratio -- how often shares are traded. If there's a big change in any of these numbers over time, or they appear larger than those of the fund's peers, inquire as to why. You can call or write the fund management team, or check financial newspapers and websites for news about the fund.
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