Read before investing: Why the prospectus matters

Open full sized image

There’s plenty of info in the fine (and not-so-fine) print.

© StockPhotoPro/stock.adobe.com; Photo illustration Encyclopædia Britannica, Inc.

A prospectus is a document that is legally required for every publicly traded stock, mutual fund, and exchange-traded fund (ETF). It lays out basic financial information, as well as the mission of the company or the fund.

Public companies must include a prospectus as part of their initial (or “S-1”) filing with the U.S. Securities and Exchange Commission (SEC), and update it with any material changes, in order to issue shares to the public. The same is true of mutual funds and ETFs, whose prospectus is called Form N1-A.

For investors in stocks or funds, the prospectus is a source of essential, reliable information. A full prospectus can be a lengthy document, full of jargon, tables, and complex formulas. But mutual funds and ETFs also have to publish a shorter, less technical “summary” prospectus, which contains much of the same key information.

Most advertisements for funds or ETFs include a disclaimer that urges you to read the prospectus before investing. The goal is to ensure only informed investors are buying the investment. But where can you find a prospectus?

A publicly traded company will post its prospectus on its website, along with other SEC filings, usually under an “Investor Relations” or “Investors” section. A mutual fund manager will usually post the prospectus on the fund’s web page. The broker or advisor who sells you the fund should also be able to provide the prospectus.

Additionally, you can find the prospectus for the stock of any publicly traded company and for every mutual fund on the SEC EDGAR database. The database includes prospectuses and every other filing made by those funds and mutual funds. But because it’s comprehensive, EDGAR can be overwhelming and take a while to wade through.

Once you’ve found the prospectus you’re looking for, here are some things you can expect to discover.

If you’re considering buying a stock in a relatively new company without a proven track record or earnings history, the prospectus can be a good place to start your research. It can also be invaluable for analyzing companies that are about to conduct an initial public offering (IPO).

The company’s prospectus explains its history, its business, who’s running the operations, and what their goals are. The document also includes hard data on the company’s revenue, profit, and expenses, along with a discussion of the risks investors in the stock may face. For a company that’s been privately held and is issuing shares for the first time, the prospectus might be the public’s first peek behind the curtain.

When you’re buying a mutual fund or an ETF, a fund prospectus is a source of legally vetted information about what the fund will invest in, how it will select securities, when it will sell those investments, and other important information.

It’s all available in the fund’s full-length prospectus, as well as its summary prospectus, depending on how deeply you want to delve into a fund’s investment objectives, goals, strategy, and risks.

A fund’s prospectus also discloses the fund’s past performance relative to its peers, and it includes a full breakdown of the fees and expenses you can expect to pay.

Today there are more ways to get investment information than ever before, but the prospectus remains a reliable, no-nonsense source of hard facts. It’s not necessarily the most inviting document, but if you learn to read one, you’ll be a more informed and perhaps more confident investor.

If you open a fund prospectus, but find it to be too much information to wade through, start with the summary. If you read a stock prospectus ahead of an IPO, but you still don’t understand the company’s mission or how it plans to make money, or if you’re concerned by what you see in its risk disclosures, that might not be the stock for you.