Mutual Fund Prospectus
If you invest in mutual funds, including index funds, one of the most important things you need to know involves a document called the mutual fund prospectus. The Securities and Exchange Commissions requires funds to file this legal document and make it available to potential investors. It is extremely important to you because it contains a tremendous amount of information that you can't get elsewhere.
- Description of the investing strategy the mutual fund management company will use to invest your money. Some funds follow a value investing strategy, some go for growth stocks, while still others may use risky strategies involving stock options. These days, a popular mutual fund strategy is based on mimicking an index such as the S&P 500.
- Breakdown of the historical expenses paid by the mutual fund shareholders over the past few years, including management fees, 12b-1 fees, sales loads, redemption fees on shares sold within a certain period of time, and other relevant information. This can include minutia such as the fees charged by the transfer agents to handle paperwork on behalf of the fund.
- Long-term performance disclosure comparing the mutual fund's performance to a benchmark such as the Dow Jones Industrial Average. The mutual fund prospectus may explain why a certain benchmark is the most appropriate comparison.
- Major risks you are likely to face when investing in the particular mutual fund. For example, a global or international mutual fund prospectus is probably going to spend time explaining currency risks, the possibility of companies implementing capital restrictions, the dangers of war, and other considerations that are less relevant (under most circumstances) to a purely domestic mutual fund.
- Whether or not the mutual fund employs leverage; whether the mutual fund lends its own securities out to others, such as short sellers, in exchange for income.
- Names of the directors or trustees who represent the mutual fund shareholders, including the range of their investment in the fund (e.g., $10,0001 to $50,000 or $100,000+)
- Amount the directors are paid for their service
- Control persons and principal owners of the fund, including the institutions holding securities on behalf of the actual investors in "street names"
- Information about the managers of the mutual fund assets to help you determine whether or not you think they have the credentials, experience, and temperament to handle your money
- Range of investment the people making the decision about the fund's investment strategy (the portfolio manager or members of the investment committee) have in the fund itself so you can decide whether they are sufficiently exposed to the risks of their decisions (e.g., "John Smith, the Chief Investment Officer, has $100,001 to $500,000 of his own money invested in the ABC mutual fund, and $500,001 to $1,000,000 of his own money invested in the XYZ mutual fund".)
- Portfolio turnover rate, which can give you some idea as to the tax-efficiency of the fund (longer holding periods tend to result in deferred tax liabilities, which can be a good thing under some circumstances).
Acquiring a Prospectus
Mutual fund companies are required by law to provide you with a prospectus before you invest. Virtually all fund companies now make their prospectus available online as a free download. It sounds overly simplistic, but you can either search for "[Fund Name Here] prospectus" in your favorite search engine or find the official mutual fund website and look around because it's sure to be listed somewhere nearby. Most funds want you to read it because they want you to hand over your cash so they can begin earning fees on it, making sure you know what you're getting and that you are happy with the arrangement.
In recent years, many of the largest online stock brokers have included a link to the mutual fund prospectus on the research results that are displayed if you search the ticker symbol on the broker's site.
Once you read a few dozen mutual fund prospectuses, you should start to recognize what is normal and what isn't. This is important because, if you are wise, it can aid you in constructing a better portfolio for your own needs. At the very least, you'll be able to avoid abominations such as leveraged ETFs, which have no place in the portfolio of most investors.
The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.