(MONEY Magazine) – Have you ever met an investor who bought a mutual fund based entirely, or even mainly, on what its prospectus said? I never have. But I've met scads of people who bought a fund because it looked good on a chart.

The government agencies and private organizations that oversee mutual funds spend huge amounts of time and energy nitpicking over how fund prospectuses are worded. But I think they sometimes overlook another area that's at least as important: the flashy and often peculiar ways that funds show their performance in charts. The watchdogs at the Securities and Exchange Commission, the government agency that regulates funds, and at the National Association of Securities Dealers, which enforces many of the SEC's rules (and reviews all performance-based fund ads), go over every word in a fund's documents. But even the regulators admit that most people don't read prospectuses--and when it comes to the stuff that people do look at, like charts and graphs, the rules get a little fuzzy and squishy.

Ain't no mountain high enough

"Mountain charts," which show the growth in an investment over time, are the most common way to display fund performance visually. I'm not saying that anyone in the fund industry uses these charts to mislead investors intentionally, but the charts can be confusing--to say the least.

Look at the two ads on this page. The left one ran in the Wall Street Journal on April 29, 1998; the right one ran in Kiplinger's in June 1998. Which fund would you rather own?

At first glance, the fund on the right looks better, since its mountain of wealth is higher. But both charts show the growth of an identical investment over the same time period in the same fund, American Century Growth. In the chart on the left, the returns are plotted on a grid that is seven squares wide by seven squares high, while the grid on the right is six squares wide and eight squares high. That subtle change stretches the right-hand chart up like an erupting volcano, making it look roughly 10% hotter.

"The ad in the Journal ran in a horizontal space, and the one in Kiplinger's ran vertically," says Catherine Bernard, director of corporate advertising at American Century Funds. "To maintain the same proportion of white space in each ad, we had to change the shape of the chart. It was an art direction issue. We don't think it's misleading."

Now let's look at a chart of the Spectra Fund taken from an ad in a trade magazine, Dow Jones Investment Advisor, last September (see the next page). The right side of the chart states that a $10,000 investment grew to $608,138--but the scale on the left clearly shows that the mountain chart tops out around $625,000.

James Connelly, senior vice president at Fred Alger Management, which runs Spectra, says: "What you're saying is indeed correct. The line is slightly above where it should be. We weren't trying to mislead readers. Our graphing software ended the line before the right frame of the chart, and someone at our ad agency must have manually carried the line over. We assumed the visuals were correct because the numbers we input were correct--but we're never going to assume that again."

How to scale a mountain

Finally, let's check out an ad from the Pioneer Fund (at left on the facing page), which ran in the trade magazine Investment News on March 23, 1998. The quiet green line at the bottom is Standard & Poor's 500-stock index, which turned $10,000 into "only" $13 million between March 1928 and February 1998. The hot red line is the Pioneer Fund, which multiplied $10,000 into nearly $66 million over the period.

The two lines are shown on an arithmetic scale, which plots data at equal intervals: The vertical distance between $10 million and $20 million, for instance, is equal to the vertical distance between $20 million and $30 million. But that can skew a chart. After all, $20 million is 100% more than $10 million--while $30 million is only 50% more than $20 million, $40 million is just 33% more than $30 million, and so on. By displaying these declining percentage changes at constant intervals, an arithmetic chart can steepen a moderate slope of growth into a Himalayan cliff.

That's why, when scientists display statistics showing rapid growth, they often use what's called a ratio scale. That way, when numbers increase by equal percentage amounts, the height of the line that illustrates them increases by equal amounts too. Using the actual returns of the Pioneer Fund over time, we've redrawn its arithmetic chart on a ratio scale to show you how this narrows the visual gap between the fund and the S&P 500 (see below right).

"This ad was for a broker-only audience and was never designed for retail investors to see," says Pioneer spokeswoman Anne Patenaude. "We use a ratio scale for all of our ads in retail publications because we think it usually gives a fairer picture."

Thomas A. Pappas, who oversees fund advertisements at the NASD's regulatory unit, cannot comment on specific cases, but he notes that fund companies must calculate performance according to SEC and NASD rules and must make sure that charts are not "materially misleading."

Of course, "materially misleading" is in the eye of the beholder. Mountain charts can easily slip under the regulatory radar, and there's little to stop fund companies from opening your wallet by fooling your eyes. My advice: Never buy a fund just because it looks good on a mountain chart, and be sure you take a cold look at the numbers behind even the hottest-looking chart. Until we get tougher and more consistent standards for the visual display of fund returns, these are uncharted waters.

Jason Zweig can be reached at fundamentalist@moneymail.com.