In investing, a prospectus is a legal document that describes an investment security to potential investors. Required by the U.S. Securities and Exchange Commission (SEC), a prospectus contains facts about the company or fund issuing the security. This can include details on its finances, management, history and other information that could help investors make an informed decision. A prospectus is a key tool in an investor’s toolbox, as it allows them to understand a security’s risks and strategies. If even after reading an investment prospectus you still have questions, consider working with a financial advisor.
What Is a Prospectus?
A prospectus is a legal document that a company or mutual fund must produce when it is offering a security for sale. The prospectus provides detailed information about the security so that potential investors can better understand what they’d be buying. Among other things, this information can include:
- Background on the company and its current financial situation and principals
- How many total shares are being issued
- The type of security being issued (stock, bond, mutual fund, etc.)
- The name of the institution underwriting the offering, if there is one
- Information about dividends
This information is meant to notify potential investors that the security is either coming or is currently available. In addition, a prospectus can help investors determine whether the security might be a fit for them.
A prospectus typically comes in two different forms: preliminary prospectuses and final prospectuses. When a company or fund is preparing to release a new security, it will issue a preliminary prospectus. Then, once the offering is complete and actually available to investors, a final prospectus will also be available. The two versions will likely have many similarities, with the final prospectus containing more details and any changes that took place during the finalization process.
How to Find and Read a Prospectus
Before you can even read a company or fund’s prospectus, you’ll need to find it. The way to do this is to visit the SEC’s website, which houses a database called Electronic Data Gathering, Analysis and Retrieval, or EDGAR. There are a number of ways you can search for the prospectus you need access to, including by company/mutual fund name, ticker symbol, filing date and more.
The purpose of a prospectus is to evaluate if an investment is right for your goals, risk tolerance and existing investment portfolio. You may not need to closely read every word in the prospectus to come to this decision. In fact, it’s unlikely you will. Instead, the best approach is to read through the document with an eye for several crucial pieces of information.
The first objective when reading a prospectus is to develop an understanding of the company’s business model and goals if it is indeed a company issuing the prospectus. Once you’ve accomplished that, you’ll want to carefully consider the risk factors the prospectus lays out. Be sure to reflect on if the prospectus is portraying an investment that aligns with your personal risk tolerance.
Finally, most prospectuses will include information about what the proceeds of the security’s performance will be put toward. Consider if these align with the company’s business model and if they’ll generate consistent value.
Once you feel confident in your understanding of the prospectus, it may be worth checking to see if there’s any overlap between the security or fund in question and the investments in your current portfolio. By doing this, you can identify whether or not your portfolio will lose diversification value if you decide to invest in the new security or fund.
What’s Different About a Mutual Fund Prospectus?
A mutual fund prospectus details the strategies and objectives of a specific mutual fund. This information will differ slightly from a stock prospectus, as it will include the fund’s past performance, as well as the managers of the fund and their history. Both types of prospectuses, however, will discuss the issuer’s plans and objectives. This will allow you, the investor, to determine if it would be a good fit for your portfolio.
A mutual fund prospectus will also likely include a discussion of the fund’s investment strategy, something that isn’t applicable to a stock. This could include information about asset allocation targets or any restrictions the fund may place on its investments.
By law, every mutual fund prospectus must include information regarding the risks involved in investing in the fund. In this section, the fund will illustrate the nature of the risk you’ll assume by investing, both the magnitude and the provenance of that risk. While risk is inherent in investing, not all funds will align with your personal risk tolerance. Knowing this, you’ll want to examine this section closely before making a final investment decision.
Sometimes mutual fund prospectuses may go by different names than the ones listed above. The first of these is a summary prospectus, which gives only a short overview of the fund, its strategy and goals. The second, a statutory prospectus, is much longer and more comprehensive. If you’re looking to find the prospectus of a particular fund, you can usually get your hands on it by heading to its website or reaching out to the fund via email or phone.
The Bottom Line
A prospectus is a crucial piece of information for the potential investors of a stock or other security. It helps them understand any potential risks that could come with the purchase of the security, among other things. Without a prospectus, investors would have little to no information to help them make their decision.
Tips for Getting Into Investing
- If you’re looking to improve your investment game, it might be worth it to work with a professional. A financial advisor can help vet any potential investment and help you understand how it could fit into your plan. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Having a specific asset allocation is crucial for investors when it comes to managing risk in their portfolios. A prospectus can help you determine the asset classes of a security and whether their risk levels makes sense for you. SmartAsset’s asset allocation calculator can help you find the allocation most appropriate for your financial goals and risk tolerance.
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