Importance of a Prospectus

You can obtain a copy of a prospectus on the U.S. Securities and Exchange Commission's database called EDGAR.

You can obtain a copy of a prospectus on the U.S. Securities and Exchange Commission's database called EDGAR.

A prospectus is a regulatory document that gives you a bird's-eye view into the investment you're thinking of making. It's designed to offer shareholders transparency into the companies that issue stocks and bonds into the financial markets. Whether you're thinking of investing in the stock or bond markets, or are mulling a mutual fund investment that can help you save to buy a home or prepare for future retirement, a regulatory document known as a prospectus offers details surrounding your options.


When a company files for an initial public offering (IPO) with regulators, it's preparing to issue equity shares, or stock, in the financial markets -- probably for the first time ever. Considering that the company has been operating in the private sector, there won't be tons of information about the business at your fingertips. By reading the company's prospectus, you'll learn if the business has begun earning profits, the size of the offering and price for the new shares. Without the prospectus, you might have to learn the risk factors facing a business and its future profitability the hard way -- by watching its stock price decline after you invest in it.


The only way that you're going to be paid the interest and principal payments owed to you as a bond investor is if the issuer has budgeted for its debt obligations properly. In a bond issuer's prospectus, you'll learn how the issuer intends to pay you. In 2011, bond issuers didn't make clear to investors the extent of their liabilities, which put investors at risk of being the victim of a bond default, which means they wouldn't be paid, according to a 2012 Fox Business article. If you're going to read about the risks anywhere, it will be in a prospectus -- but even then sometimes issuers don't provide full disclosure.

Mutual Funds

If you're employer has a retirement plan they probably have numerous mutual fund options for you to choose from. By taking the time to read a mutual fund prospectus, you'll learn the strategy that the fund manager follows, such as whether he's out to beat the stock market or just protect your nest egg. The prospectus also displays the fund's past performance, which gives you a sense of the kinds of returns you can expect to earn each year.


Any prospectus is time-consuming to read, as these documents can be hundreds of pages long. You can scan, however, for some buzzwords that reflect the most important information that a prospectus has to offer. As a mutual-fund investor, you'll want to learn the size of the fees and expenses that the firm charges, which is revealed in the prospectus. Whether you're buying an individual stock or a mutual fund unit, the prospectus will reveal whether you can invest directly with the issuer or if you'll need to use a stock broker.


About the Author

Geri Terzo is a business writer with more than 15 years of experience on Wall Street. Throughout her career, she has contributed to the two major cable business networks in segment production and chief-booking capacities and has reported for several major trade publications including "IDD Magazine," "Infrastructure Investor" and MandateWire of the "Financial Times." She works as a journalist who has contributed to The Motley Fool and InvestorPlace. Terzo is a graduate of Campbell University, where she earned a Bachelor of Arts in mass communication.

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