A prospectus is a legal document.

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A prospectus provides important information about investing in financial securities. The Securities and Exchange Commission requires certain investment firms, such as mutual funds, to provide prospectuses to potential and current investors. Publicly traded companies that issue stocks and bonds must also file prospectuses with the SEC. You can request a copy of the document from the company itself. Important information typically included in a prospectus is the companys investment strategy, risk associated with investing, past performance data and associated fees and expenses. Understanding how to analyze a prospectus is critical to making prudent investment decisions.

Step 1

Analyze the date of issue. According to the SEC, investment companies must update their prospectus at least once a year. The date appears on the front of the prospectus. Check the date to verify that it is the most recent copy.

Step 2

Review the risk/return chart or table. This section is located near the front of the prospectus. An investment company must list its annual total returns for the last 10 years. Review the company’s returns before taxes and returns after taxes. Look for any listed risk factors you should consider before investing, such as volatile asset holdings.

Step 3

Review the fee table to determine the associated fees and expenses. This section includes shareholder fees and operating expenses. Determine how the fees affect past and estimated returns. Most mutual funds provide a hypothetical investment scenario to show how fees compare to returns over a certain period of time.

Step 4

Read information about the management of the investment company. According to the Missouri Secretary of State, this section of the prospectus explains managements experience and what each member of the management team plans to bring to the company. You should reconsider investing in a financial security if managers are inexperienced or cannot devote their full time to their duties.

Assess the financial highlights section located near the back of the prospectus. This section contains audited data concerning the funds annual financial performance for each of the previous five years. Review the beginning and ending net asset value, important financial ratios and the portfolio turnover rate. Proceed with caution if the fund’s turnover rate is high. Companies with high turnover rates incur more fees than companies with lower turnover rates.

Check the issuers capitalization for companies that issue stocks or bonds. This informs you how much the company is worth. Review the companys debt load, including both short-term and long-term debt. Verify that the companys income is adequate to pay expenses and earn a profit. Reviewing this information is important to determine whether the company can pay its investors and lenders or if it is at risk of financial problems in the future.