Definition: A mutual fund prospectus is a document that provides investors with important details about the fund, such as the investment strategy, fees, risks, and the fund company. The prospectus can be a great tool for investors to analyze whether investing in a particular fund is suitable for them.
How Does a Mutual Fund Prospectus Work?
A mutual fund prospectus is a document that informs investors about important details regarding their mutual fund and the company managing the fund. Mutual funds are required to send a prospectus to investors after they purchase a fund, although investors can also request a prospectus prior to investing.
Types of Mutual Fund Prospectuses
There are two types of mutual fund prospectuses that differ based on the amount of information they provide:
Legal Prospectus:
A detailed document that includes information about investment objectives/goals, fees, risks, performance, management, shareholder information, and commissions. A legal prospectus must be distributed to all shareholders.
Summary Prospectus:
Most funds also produce a summary prospectus, which is a shorter document that contains more marketing language than legal language. Both prospectuses should be analyzed before purchasing.
How to Read a Mutual Fund Prospectus
To understand where to look for information in a mutual fund prospectus, let’s review each section of the legal prospectus. There are three main parts in the legal prospectus:
Part One: Investment Objective, Strategies, and Risks
Most funds focus on either increasing the value of shares or generating income through dividends or bonds. This part of the prospectus will outline the strategy employed by the fund to achieve this goal. Given the importance of investors understanding whether the fund fits their investment profile, this first part of the prospectus also contains the risks associated with investing in the fund.
Part Two: Fee and Performance Table
Think of this part as a cost-benefit analysis for the fund. The fees and commissions associated with the fund will be listed, while at the same time describing the fund’s historical performance. The part includes three sections of fees:
- Transaction expenses for shareholders: These are the expenses related to buying or selling shares in the mutual fund. This includes sales and redemption fees, as well as account maintenance fees.
- Annual operating expenses of the fund: These are the expenses incurred by the mutual fund to operate the fund. This includes the expense ratio that reflects the fund’s management costs, 12b-1 fees paid by brokers for selling the fund, and management fees. A hypothetical example: This example illustrates investor costs in a typical year.
The prospectus will also include tables and charts showing historical performance with comparisons to relevant benchmarks, as well as a statement that past returns are not a guarantee of future returns.
Part Three: Management and Shareholder Information and Additional Information Statement
The prospectus lists the management company that advises the fund and the individual portfolio managers responsible for making investment decisions. Following this is information on how to purchase shares of the mutual fund, dividend distribution options, and possibly information on how to exchange shares of a fund for shares of another fund in the same fund family. Ultimately, the additional information statement will typically include bios of the portfolio managers and how long they have been with the fund, along with other disclosures.
What Does This Mean for Individual Investors?
The mutual fund prospectus is the primary document to research a potential new investment in a mutual fund. Let’s review some good practices to utilize in the most important sections.
Investment Objectives/Goals
The investment objective provides insight into what the fund aims to achieve and the risks it is willing to take to achieve those goals. While investment strategy alone may not determine your investment decision, it’s good to consider the different objectives of the funds you already own. For example, if you already own three mutual funds that specialize in real estate in South America, it might be wise to diversify your investment with the next fund.
Fees
Commissions
Due to compound interest, fees as low as 0.25% can lead to significant changes in investment outcomes. Let’s assume you have $100,000 to invest in a fund that achieves an annual return of 4% for 20 years. If there are no fees or expenses, your initial investment will grow to over $219,112. Here’s how any fees affect that return:
- 0.25%: $25 for every $10,000 invested – approximately $208,000 after 20 years.
- 0.50%: $50 for every $10,000 invested – approximately $198,000 after 20 years.
- 1.00%: $100 for every $10,000 invested – approximately $179,000 after 20 years.
Exchange-traded funds (ETFs) have contributed to reducing fees in the industry over the past decade. For many strategies, there is a low-fee ETF alternative available.
Risks and Performance
Risks are often written in standard legal language that doesn’t change much from fund to fund. The key to analyzing this section is to find the risks you don’t already understand. Risks related to countries, concentration, and even issuer risks that you haven’t faced before should be considered in your decision-making.
While past performance does not guarantee future returns, consistently poor past performance may be a good indication that it is better to invest in an index fund. If the fund has continually underperformed compared to the index, it may be wise to take the time to determine if you can simply invest in the index instead.
Frequently Asked Questions (FAQs)
Where can I find the mutual fund prospectus?
If you purchase shares in a mutual fund, the financial company is required to send you the fund’s prospectus. As a potential investor, you can request a mutual fund prospectus from the financial company or your broker. Links are available on the websites of many investment companies that allow you to view or download the fund prospectus.
What should I pay attention to in the mutual fund prospectus?
Although the mutual fund prospectus contains a lot of important information, investors should pay special attention to certain key sections. Information about investment strategies and risks helps investors understand the goals the fund aims to achieve and the risks it intends to take to achieve those goals. Fees and commissions can affect investment returns, so it’s important to understand how much you are paying for that. Investors should also check the fund’s historical performance and details about the fund manager. While past returns do not guarantee future profits, a fund’s performance during tough times can give you an idea of how your investment may be impacted.
Sources
The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts in our articles. Read our editorial process to learn more about how we fact-check and maintain the accuracy, reliability, and quality of our content.
Vanguard. “Models and Applications.”
Charles Schwab. “Investor Information.”
Investor.gov U.S. Securities and Exchange Commission. “Mutual Fund Prospectus.”
Investor.gov U.S. Securities and Exchange Commission. “How to Read a Mutual Fund Prospectus (Part 1 of 3: Investment Objective, Strategies, and Risks).”
Investor.gov U.S. Securities and Exchange Commission. “How to Read a Mutual Fund Prospectus (Part 2 of 3: Fee and Performance Table).”
Investor.gov U.S. Securities and Exchange Commission. “How to Read a Mutual Fund Prospectus (Part 3 of 3: Management and Shareholder Information and Additional Information Statement).”
U.S. Securities and Exchange Commission. “Investor Bulletin: Fees and Expenses of Mutual Funds,” page 2.
Source:
https://www.thebalancemoney.com/what-is-a-mutual-fund-prospectus-6753466
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