How to Read a Mutual Fund Prospectus
S&P Capital IQ
A prospectus provides essential information to mutual fund investors, and should be read before making an initial investment. This article provides an overview of the key elements contained in a mutual fund prospectus.
A mutual fund prospectus can be a valuable source of information for a particular fund or to evaluate its performance relative to other funds. Prospectuses are legal documents that must adhere to rigorous standards set forth by the Securities and Exchange Commission (SEC). Accordingly, they are an excellent source for information, presented objectively and consistently.
The information in a mutual fund prospectus includes:
- Performance data — selected per-share data including net asset value and total return for different time periods as prescribed by SEC guidelines.
- Minimum investments — for initial and subsequent investments.
- Investment objectives — with fund goals clearly defined. (Be sure the fund's objective matches your objective.)
- Investment policies — the general strategies of the fund and what types of investments it can invest in.
- Risk factors — descriptions of the risks associated with investments in the fund.
- Tax information — among other information, an indication if distributions are to be treated as dividend income or capital gains.
- Fees and expenses — including all sales and management fees; also a display of the impact these fees and expenses would have on a hypothetical investment over time.
Make sure the prospectus you're using is up-to-date; the SEC requires that prospectuses be updated at least annually. Prospectuses are available free from mutual fund companies, brokers, or registered representatives. Be sure to read the prospectus and ask questions about items that you are not sure about before investing.
There is no shortage of information about mutual funds. Countless Web sites and online publications offer reams of data on the thousands of mutual funds issued in and outside the United States. What's more, many books, magazines and other print publications also provide extensive data and analysis on mutual funds.
But there is only one definitive source for mutual fund information: the fund prospectus. The prospectus is issued by the fund provider and it contains all the detailed data and information investors need when choosing a fund. Wading through this sometimes complex document, however, may take perseverance and a strong cup of coffee.
Think of the prospectus as your travel guide to the world of mutual funds -- it provides all the details you need to map out a successful investment plan. At first glance, of course, a prospectus may not look as reader-friendly as you would hope. It is, after all, a legal document that must adhere to rigorous standards set forth by the Securities and Exchange Commission (SEC), the federal agency that oversees the mutual fund industry.
But with a little basic knowledge of the information contained in a prospectus, you can make effective use of this valuable investment planning tool.
Some Questions to Ask Before Investing
- In what does this fund invest?
- What is the long-term rate of return?1
- How much has return fluctuated in the past?
- How does the fund's performance compare with that of the underlying market?
- Is the fund seeking income or capital growth?
- What time frame is appropriate for an investor in this fund?
- What are the fees associated with this fund?
How Can a Prospectus Help You
Consider these examples of hypothetical situations in which the information found in a prospectus could have been very useful:
- An investor sells his mutual fund shares and is surprised to learn that a portion of the sale price is paid to the fund company in the form of a back-end load.
- An investor exchanges her investment in one fund for another fund in the same fund family. She did not know that fees were charged for the exchange.
- A retiree in search of income invests in a high-yield bond fund but doesn't know it is also high-risk and is disturbed by its fluctuating value.
- Attempting to make a mortgage payment with money from a mutual fund account, an investor discovers that the fund places a minimum amount on its check-writing privilege.
All of the necessary information to prevent these occurrences is contained in every mutual fund's prospectus. Take a look at these key elements:
Date of issue - First, verify that you have received an up-to-date edition of the prospectus. A prospectus must be updated at least annually.
Minimum investments - Mutual funds differ both in the minimum initial investment required and the minimum for subsequent investments.
Investment objectives - The goal of each fund should be clearly defined - from income with preservation of principal to long-term capital appreciation. Be sure the fund's objective matches your objective.
Investment strategies - A prospectus will outline the general strategies the fund managers will implement. You'll learn what types of investments will be included, such as government bonds or common stock. The prospectus may also include information on minimum bond ratings and types of companies considered appropriate for a fund. Be sure to consider whether the fund offers adequate diversification.
Risk factors - Every investment involves some level of risk. In a prospectus you'll find descriptions of the risks associated with investments in the fund. Refer to your own objectives and decide if the risk associated with the fund's investments matches your own risk tolerance.
Performance data - You'll find selected per-share data including net asset value and total return for different time periods as prescribed by SEC guidelines. Performance data listed in a prospectus are based on standard formulas established by the SEC and enable you to make comparisons with other funds. Remember that past results do not guarantee future performance. When evaluating performance, look at the track record of a fund over a time period that matches your own investment goals.
Fees and expenses - Sales and management fees associated with a mutual fund must be clearly listed. The prospectus will also display the impact these fees and expenses would have on a hypothetical investment over time.
Tax information - A prospectus will include information on the tax status and implications of a fund's distributions -- whether they will be treated as dividend income or capital gains.
Investor services - Shareholders may have access to certain services, such as automatic investment of dividends and systematic withdrawal plans. This section of the prospectus, usually near the back of the publication, will describe these services and how you can take advantage of them.
The Summary Prospectus
The Securities and Exchange Commission permits the use of a simplified summary prospectus to help investors better understand key characteristics of a mutual fund investment.
Ask your mutual fund company for a summary prospectus, if available, in addition to the regular prospectus.
To simplify the process of reviewing mutual fund prospectuses, certain information is required to appear in the same place. For example, the fee table and performance table must appear at the beginning of the prospectus.
While the rest of the material can appear in any order, you'll generally have no trouble finding the information you need -- prospectuses generally range from 10 to 20 or more pages and include a table of contents. And after reviewing a few prospectuses, you'll become accustomed to the language and be able to reduce the time it takes to find the information you need to make a sound investment decision.
You can receive prospectuses free from mutual fund companies, a broker, or a registered representative. Be sure to read the prospectus and ask questions about items that you are not sure about before investing. Your financial planner or broker should be able to answer any questions.
Points to Remember
- Think of your prospectus as a travel guide to the world of mutual funds.
- Ask your fund company for a summary prospectus in addition to the regular prospectus.
- Note tax information you'll find in a prospectus -- whether distributions are to be treated as dividend income or capital gains.
- Sales and management fees associated with a mutual fund must be clearly listed in a prospectus. Note the impact these fees and expenses would have on an investment over time.
- Make sure the prospectus you're using is up-to-date. A prospectus must be updated at least annually.
1Past performance isn't a guarantee of future results.