Friday, June 8, 2012

My How To: Read a Mutual Fund Prospectus

Since we’ve returned from our recent Carolina getaway I have found that I am a lot more steady (and that’s a nice way to put it) in my thoughts and approaches to personal finance. Over the past three and a half years I have studied, read, studied some more, read and put into application personal financial practices that have lead me to where I am today.  Lately I have recognized that when I am reading thoughts and philosophies on personal money management that contradict what I do, I feel an intense hatred and anger boil up inside of me. In recent days in fact I have avoided them entirely.

Now this is not to say that I am closed off to new information and growing in intellectual depth. I am saying that I am sick and tired of reading asinine articles that preach that carrying multiple credit cards and keeping my credit score up is the way to go in personal money management. In my three and a half years of intense study, research and real world field application I know where North, South, East and West are. I’ve just about had it with morons trying to convince me that South is North and East is West.

What triggered the recent anger sharks to swim in my head was, oddly enough, one of my favorite publications that I receive quarterly for free. Now while this publication has a strong and reputable standing within the financial community (which should have been my first clue that it would spew garbage) I was dumbfounded to read their latest publishing that touted their revolutionary new approach to filtering and screening mutual funds.

I’ll spare you the name of the publication and the details, but most of the features were filled with mind-numbing jargon written by people too smart for their own good. Through all of the garbage and this publications’ new and improved way to measure and evaluate mutual funds, NOT ONCE did the publication’s articles factor into their new and improved evaluations a mutual funds average annualized return since inception. I mean there were evaluations on “stewardship” and “portfolio manager tenure” as well as “transparency whether the pm is invested in the fund,” but something like historical returns and performance just seemed to have slipped the writers minds.

So here I am to do my part to help empower the consumer to read a mutual fund prospectus. Now before I even get to this point a few disclaimers:


I strongly advise against investing until you have completed your debt snowball and eliminated your consumer debt (everything but the house and, if it applies, a student loan that you cannot be free of within 2-3 years) and have a liquid 3-6 months worth of expenses set aside in a liquid emergency fund. Once you have eliminated debt and have a cushion against life, you can utilize your best wealth building tool, your income, to start investing.

When investing always think long term. Not long term like a year, more like increments of five years. For every dollar you put in to invest don’t expect to redeem it for at least five years. Give your dollars some time to ride out bull and bear market cycles and ride the power of compound interest over a substantial period of time.

Now before I even start scrolling through a prospectus I filter my options so that my investments are spread across four types of mutual funds: growth, aggressive growth, growth & income, and international. The funds have to be at least 10 years old and have average annualized returns of over 12% since inception, no ifs ands or buts. So now that I’ve lovingly made you jump through some hoops, onto a real life prospectus example.

Heartland Value Fund
Ticker: HRTVX

The Investment Goal

I’ve always found that if the investment goal is a paragraph long, then the mutual fund team is too smart for their own good and believe too many myths about trading and investing. Short and simple does not mean unsophisticated, it simply means (haha, see what I did there J) that the team managing the mutual fund know exactly what they are trying to achieve without gimmicks or tricks. For HRTVX the goal is simple, grow the investor’s money over a long period of time by investing in small companies. So for a 5+ year investment, so far this one has my green light.

Fees and Expenses

Now for the debate of all debates when it comes to picking mutual funds: to load or not to load? Essentially the debate boils down to how much is too much when it comes to paying fees. My thoughts are essentially this: if the fund sucks and doesn’t generate much of a return for long term investing, don’t bother investing even if there are minimal fees. If a fund is a rock star and has averaging over 15% since inception, I don’t mind paying 2%, 3% or even 4% in fees if the performance justifies it.

Ideally I love tracking down great performing mutual funds with minimal fees, but am flexible to take on higher fees if long term performance justifies it. In the example above  there is a breakdown of shareholder and annual fund operating expense fees. In the shareholder fee portion, the only thing you’ll pay is 2% if you redeem your shares purchased within 10 days, which you shouldn’t be doing anyway. On the Annual Fund side fees total to a just over 1% for investor class shares. So at this point we know the fund invests for the long term and has very low fees, next up:

Portfolio Turnover

If this fund is investing for the long term and keeping expenses low, then you need to know if their stock picking is slow and steady or needs some A.D.D medication. Over the last year HRTVX has a turnover rate of 25% of its portfolio. Which means for every 4 stocks the fund holds at the end of the year they drop one. To me 25% is a good turnover rate, the mutual fund team appears to do excellent in depth research in the stocks they select and for the most part buy and hold. If the Portfolio Turnover number  is over 50% be wary, if it flits with or goes OVER 100%, stay away from it.

Investment Strategies

So how does a mutual fund team select the stocks for its mutual fund to hold? This is a great question. This fund clarifies that it invests in small companies and qualifies how it defines small companies. As it invests in small companies, this would be classified under my "aggressive growth" mutual fund screening criteria. HRTVX looks for undervalued small companies and says, “these companies have upside and will grow as a long term investment.” Unique to this fund is a trademarked “10 Principles of Value Investing” that the investment team uses. I won’t run you through this funds’ specific 10 principles, but essentially they look for undervalued companies with low debt (always a plus in my book) and have strong signals of long term growth. So the next question is does this fund deliver?


The numbers speak for themselves. The fund has been around for 27 years and has average annualized returns before taxes of 12.37%. Don’t pay attention to the one or five year tracks, when investing I am always thinking long term and not looking to jump in and out of short term market swings. I want something that has stood the test of time, multiple market cycles and has generated strong and steady returns since it started. So far this fund is a winner in my book.

Portfolio Manager Tenure

Mutual fund teams are lead by the focus and drive of the mission statement and team leaders called portfolio managers. This fund is lead by 3 managers. One of which has been there since the fund’s launch, another for 8 years and another for 2 years. Sounds to me like this fund will have a  change on the horizon as the longest tenured manager could be on the way out. But with average annualized returns of over 12% since inception, you can be assured that the knowledge and experience with the fund’s stock selecting strategy have definitely been passed on. Overall I say this mutual fund is a winner.

So there you have it, a walk through a mutual fund prospectus. Happy hunting out there!

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