Why Read the Mutual Fund Prospectus?

A mutual fund prospectus is to a mutual fund what an owner’s manual is to a car. If you want to learn more about what’s under the hood of your mutual fund, check out the prospectus.

If you purchase a mutual fund, you’re assured to receive a prospectus. The SEC requires the fund company to provide you with a prospectus upon purchase of the fund. This prospectus can be quite daunting as it is full of legalese, numbers and jargon. But don’t be so fast to toss it out. The mutual fund prospectus is a valuable tool that contains important information.

Key Information in the Prospectus

Investment Objectives -- The goal of the fund is defined in the prospectus. Each mutual fund has a different goal. One fund may have a goal of income with preservation of capital while another fund’s goal might be long-term capital appreciation.

Investment Strategy -- The prospectus details the strategy of the mutual fund. Does the fund invest in stocks and/or bonds? The strategy section will describe if the fund is focused on US investments or international investments or a combination of the two, known as global investments.

Shareholder Information -- The prospectus provides information relating to the purchase and redemption of fund shares. Minimum account balances and tax consequences of buying, selling, holding, or exchanging shares of the fund are listed in this section of the prospectus.

Risks -- The prospectus describes the risks associated with investing in the fund. If the fund invest in equities, for example, prospectus will discuss risks of investing in the stock market. The prospectus will also list risks of investing in the particular strategy of the fund. For example, the prospectus for the US large cap fund Vanguard 500 Index reads: “Large-cap stocks tend to go through cycles of doing better -- or worse -- than the stock market in general. These periods have, in the past, lasted for as long as several years.” You should read about, and understand, the risks of the fund prior to investing.

Performance Information -- You will find performance information sliced in many ways in the prospectus. The total return for various time periods since inception including: calendar year returns, trailing period returns (1 year, 3 year and 5 year, for instance), and both before tax and after tax returns. The performance data is based on formulas set forth by the SEC which allows you to compare performance from one fund to the next with confidence that you are comparing apples to apples. There is probably no reason for me to mention that past performance doesn’t guarantee future performance (but we can hardly discuss performance without the caveat).

Fees and Expenses -- The prospectus lists the shareholder fees and the annual operating expenses of the fund. The shareholder fees consist of sales charges and redemption fees. The operating expenses -- also known as the expense ratio -- include management fees and 12b-1 fees. The prospectus also includes a hypothetical investment and the impact these fees and expenses would have on the hypothetical investment over time. The hypothetical example will allow you to compare the costs of investing in one fund covered by the prospectus versus costs of investing in other mutual funds.

Financial Highlights -- The financial highlights section of the prospectus includes audited data that is derived from the fund’s financial statements. The data is listed in a table and includes a reconciliation of the beginning period net asset value and ending period net asset value (for five calendar years). In other words, what was the fund worth at the beginning of the year, how much did it earn, what were the charges, and how much was the fund worth at the end of the year.