A little research goes a long way. Before you purchase shares of a mutual fund, make sure you’re equipped with facts about that fund’s goals, strategies and level of risk.
This information and more is available to you in a single document – the mutual fund’s prospectus.
Know the Prospectus Basics
A prospectus is a formal document, required by the Securities and Exchange Commission (SEC), that describes the details of a mutual fund. Funds must provide shareholders with a prospectus, but you can and should request one before you invest.
As intimidating as it may appear, a mutual fund’s prospectus contains a wealth of information. The document describes how to purchase and redeem shares and details the fund’s objectives, strategies, degree of risk, fees and past performance. Also, all key data is presented in a standard format so you can compare different funds.
All Things Considered
Here are some key points to consider when reading a fund’s prospectus:
Investment objectives. The prospectus outlines the fund’s goals. In addition, it describes the kinds of securities the fund will purchase in order to achieve its goals. With this information on hand, you can determine whether or not the fund is in line with your personal investment strategy.
Level of risk. The investment risk section of the prospectus details the risks associated with the securities a fund holds. Decide whether or not the fund will match your tolerance for risk.
Cost of the fund. Included in the prospectus are tables describing the fund’s fees and expenses, which include the shareholder fees (charges incurred when you make a transaction) and annual fund operating expenses. One table includes a hypothetical example with specific dollar costs to help you compare among different funds.
Another table lists ongoing annual fund operation expenses that are deducted from the fund’s assets (and your return).
Past performance. Near the front of the prospectus is a bar chart showing the fund’s annual returns for the past 10 years, or since the fund's inception if it does not have a 10 year history. Also, funds must include a table that displays both before- and after-tax returns for the past 1-, 5- and 10-year periods. The returns for the fund's benchmark index are also included in the table, so you can see if the fund has outperformed the index over time.
The financial highlight section shows the fund’s most recent performance. Mutual funds must update their prospectuses at least once a year, so make sure you have the latest version in hand.
Fund management. The prospectus also provides information about the current fund manager’s investment strategy. You may want to consider how the fund’s management will affect fees and returns.