Reading the new prospectuses (2)

Zoomer | January 1st, 2006

Now here are some of the other important points to look for:

Fees and expenses: There are a lot of numbers here but check through them carefully. They outline exactly what costs you will have to pay, including sales commissions and annual fees and expenses. If you’re buying the fund using a deferred sales charge option, see how much you’ll have to pay if you decide to sell. Also, check if the percentage is calculated on your original purchase price or on the market value of the units at the time of sale. If the fund increases in value, the latter method becomes much more expensive. Also, many fund companies charge for early redemption, even on no-load or front-end load funds, so check for this. Sometimes you can find some angles for reducing your commissions here, such as low-load options or negotiable back-end loads.

Purchases, switches and redemptions:

This segment provides all the key information you need about the actual procedure for buying fund units. Look especially at how much is required for the initial investment — you can’t get into some funds unless you’re prepared to invest several thousand dollars. In most cases, however, the mimum is $500 or $1,000.
Provincial limitations:
Some prospectuses will state that the funds are not sold in certain provinces. That’s because they have not been registered with the provincial securities commissions in those jurisdictions. In other cases, there may be no definitive statement of where the funds are available and you may have to contact the manager directly.
Income tax considerations
: If you’re investing outside a registered plan, you’ll want to take a close look at the tax implications. In doing so, remember that payments from mutual funds are taxed differently, depending on their source. The prospectus should outline which types of payments can be expected from the fund you’re considering. There are several possibilities: capital gains dividends, Canadian stock dividends, foreign stock dividends, rental income, straight interest, and return of capital. You should understand which types of income you can expect to receive and determine whether this makes the best sense for you from a tax point of view. For example, if you want to shelter the maximum possible amount from taxes, you may look for funds that will generate capital gains, Canadian dividends, and return of capital, rather than interest income. Once you’ve invested, the fund manager will issue an annual reporting slip for tax purposes, showing exactly how much of each type of income you receive each year.

A mutual fund prospectus may seem daunting at first glance, but you don’t have to read it cover-to-cover. Just go to the specific information on the funds you’re considering and then look at the key point we have outlined here. By spending 15 or 20 minutes, you may avoid an investment mistake that could end up costing you hundreds or even thousands of dollars.

From Gordon Pape’s 2002 Buyer’s Guide to Mutual Funds, to be published this fall by Prentice Hall Canada. To order an advance copy of this book at a special pre-publication price, go to http://www.gordonpape.com