How to Analyze a Prospectus

The Securities Exchange Commission requires a mutual fund to update its prospectus once a year. Read the issue date that’s stated on the prospectus front cover to make sure you’re accessing the most recent information regarding the goals and performance history of the mutual fund. Only recent information will enable you to compare one mutual fund with another effectively and determine if the fund aligns with your personal investment goals and risk tolerance.

Located at the front of a prospectus will be the mutual fund’s investment goals and strategies. Read this section carefully because it’s important that a fund’s investment goals, such as income generation or capital appreciation, match your own. Also important is the fund’s investment strategies, which refer to the asset classes in which the mutual fund invests your money. For instance, a mutual fund might focus on stocks, bonds or real estate. This area of the prospectus will also describe the fund’s investment style, which indicates the fund's management preference for short-term or long-term investments and domestic or international investments.

Available near the front of the prospectus, following the description of the fund’s goals, are risk data and a returns bar chart and table. While the risk data explain the principle risks related to the securities in the fund, the returns bar chart illustrates the fund’s annual total returns for each of the most recent 10 years. The fund company also provides a table in which historical returns information is presented on a pretax and after-tax basis for one-, five- and 10-year periods. Also provided in the table is similarly summarized data for a benchmark index. You can compare this information, which illustrates the fund’s volatility, to the level of portfolio risk that is acceptable to you as well as your expectations regarding returns.

The mutual fund company presents a fund fee and expense table to ensure investors are aware of the costs of investing in the fund, and to enable them to compare these costs with those of other funds. For example, the table may present a breakdown of the fees and expenses that are incurred in one-, three-, five- and 10-year increments from a $10,000 investment. Such fees will include management fees and possibly 12b-1 fees as well as other expenses, such as administrative costs and transfer agent costs, each of which lowers the investors’ returns. The investor incurs these fees regardless of the fund’s performance.

To evaluate a mutual fund’s past performance, see the audited information presented in the financial highlights section of the fund’s prospectus. Here, the fund’s one-, five- and 10- year average returns are presented. In this section, you can also see the fund’s beginning and ending net asset values and some financial ratios that reflect the fund’s performance. For example, the net income-to-average net assets, portfolio turnover rate and expenses-to-average net assets ratios are presented.