What to look for in a fund prospectus

A prospectus breaks down a fund’s goals

Just as investing in a company’s stock requires information about the company, its corporate strategy, and its management team, prudently investing in a mutual fund or exchange-traded fund (ETF) requires understanding the information contained in that fund’s prospectus.

A fund prospectus is an official legal document filed with regulatory agencies such as the Securities and Exchange Commission (SEC). It helps map out the goals and objectives of a fund, how the fund is managed, and expenses associated with investing in the fund. For many, a prospectus can appear rather complicated and filled with legal jargon. Still, as an investor, you should do your best to understand what prospectuses are, why you receive them, and what type of valuable information you can find within.

What does a fund prospectus include?

Perhaps the most essential piece of information found within a fund prospectus is that fund’s objectives, investment strategy, and level of anticipated risk. It’s vital that you thoroughly understand what the fund is supposed to accomplish (and the investments used to further this strategy) to determine if it’s suitable for your portfolio.

For instance, the fund might specify that its objective is to grow capital over time using stocks, to generate income via bonds, or any other set of goals. The prospectus may also provide information about how this is accomplished, like what investment process is used to manage the fund.

A prospectus can help investors understand risk

Alongside the fund’s strategy are statements regarding the fund’s performance and risk. It’s clearly important for you to understand the sources of such risk, which might include general market risk, interest rate risk, sector risk, etc. Additionally, it’s also important to make sure that you believe this information to be consistent with the stated objective of the fund. For example, if the goal of a fund is to generate stable and steady income, then the performance history of the fund as well as the stated risks most likely shouldn’t exhibit large swings over time and shouldn’t contain a heavy weighting towards risky equities.

A prospectus also lays out a fund’s fees

Another significant factor to consider is the fund’s fees. A proper prospectus will lay out the various fees and expenses associated with the fund, often by share class. These might include shareholder fees (e.g., sales charges and account maintenance fees) as well as fund operating expenses (e.g., management fees and distribution fees). Both are important to understand in order to see a full picture of the true costs and performance of your investments. Funds may also contain different fee structures based on how much you invest, when you invest, and when you make withdrawals.

There is much, much more in a prospectus

Of course, there are many other essential data points and considerations contained in a fund prospectus, including tax information, the fund’s holdings, who the portfolio managers are, and much more. Thus, when investing in funds, you should review the prospectus so you can decide if it’s the right investment for you!