What is a prospectus and how do I read it?

What is a prospectus and how do I read it?

By: Mat Nayie

When you first buy into a mutual fund, most people have a thousand questions. How has the fund performed in the past year? How do the fees work and which ones do I have to pay? Are there any penalties for withdrawing my money early? What happens if the fund goes out of business? All the answers to these questions are listed in what is known as a prospectus.

A prospectus is simply a book or pamphlet that lists all the information about a fund. Every mutual fund company gives out a prospectus, and sometimes, if the performance for a particular fund hasn’t done well recently, it will even come with bad news about that fund. A prospectus must be accurate. The United States Securities & Exchange Commission checks on the validity of the statements in all financial documents released by investment firms to make sure they are honestly showing people what the fund has done and what they think it will do.

When you open the front cover to a prospectus, they usually hit on three different topics right off the bat: the fees that this fund charges, the objectives of the fund and the performance of the fund. While there are other concerns when you look at a prospectus, these three things are the most important.

Most companies will present the fee schedule in an easy to read graph. Remember, the fund must disclose all fees, there can’t be any surprises.

A mutual fund prospectus is also required by the SEC to list their performance. They must list this information, even if it’s not up to the expectations of the fund. It can usually be found within the first few pages of the prospectus. Most of this data is presented in the form of a table so that reading it and understating it is simple. Also, there is no shame whatsoever in asking questions. Every investor had to start somewhere and if you don’t ask questions about a particular mutual fund before investing in it, you might just be throwing your money away.

There will likely be more information in your prospectus as well, including profiles of the managers that handle the fund, as well as the founders of the investment company and so on.

A prospectus is like a bible for whatever mutual fund you choose to invest in. With oversight provided by the SEC, a prospectus must be a honest document that shows you exactly what you’re getting yourself into with every mutual fund.

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