Updated on 12.25.06

How To Read A Mutual Fund Prospectus

Trent Hamm

Once you begin investing, you’ll find yourself receiving a wide array of financial documents. One of the most useful – and the most intimidating for new investors – is the mutual fund prospectus. This document is often written in a very dense fashion that convinces casual readers that they should be reading something else, but just a few minutes of time with a prospectus can provide you with adequate information for quickly determining if your fund is providing a good investment for you or if you should move to another fund.

Here’s the process I follow when I sit down to read a mutual fund prospectus.

I check the cover for the date of issue. First thing, I look at the cover and see what date that the prospectus was issued. All mutual funds are legally required to update their prospectus at least once a year, so if the date on the cover is more than a year old, I request a new prospectus and don’t even bother with the old one.

I read the narrative description of the fund. This is the least dry portion of the document, and it’s also right at the beginning, conveniently enough. This portion describes, in reasonably easy to read prose, the objectives and goals of the fund, the strategies for investment, and any major risks in the investment. Reading through this will give you a good organic feel for the fund.

I find (and often save) the risk/return table. This table is the meat of the prospectus; the numbers you really need to know are in this table. This table tells you the percent return before taxes, the percent return after taxes on distributions, and the percent return after taxes on distributions and sale of funds. This information is given for the last year, the last five years, and the last ten years. I usually simply average these three numbers for a clear story of where the fund is headed: the high recent number means that recent investments are doing well, while the longer-term numbers indicate how the fund has done over time.

I read the fee table. This table tells the reader how much of the fund is deducted for the fees and expenses of fund management. Unlike the risk/return table, you want the numbers for this table to be low. It’s arranged in a similar fashion as the risk/return table, indicating fees and deductions over one, three, five, and ten year periods.

I subtract the fee table values from the risk/return values to see what I actually am earning. The difference between these two is the amount you’re actually making from the fund and is the best way to compare different funds. I take an average of the one, five, and ten year values for this difference and use it as a numerical comparison between funds. This number, along with my general feelings on fund philosophy, are all I really need to know about a fund.

You can read the rest, but it’s dry and not nearly as important to the casual investor. The key questions I have about a fund is what are the goals of the fund? and how is the fund doing? Once I’ve answered those questions, I only read further if I’m actually curious about specific holdings, but the purpose of a mutual fund is that you are trusting someone else to do the actual management of specific holdings.

I can usually do this with a prospectus in about half an hour, with about five minutes of number crunching. I am now following about twenty funds that I am interested in using this method, and I only revise the information whenever they release a new prospectus.

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  1. I was under the impression that the returns shown were NET of fees already. Aren’t you double counting if you actually subtract out the Expense Ratio from the shown returns?

    -William Wallets
    A Financial Revolution

  2. Trent Hamm Trent says:

    You are correct, William. I use this figure as a hedge against excessive expense ratios, because on down years excessive expense ratios can burn beginning investors very, very hard.

  3. js says:

    Do look carefully at those after tax returns to see the rate of taxation. Of course if it’s an index fund this should in theory be fairly low as well. And if it’s a retirment fund it’s probably not a concern.

    I can’t overstate it, taxes can be a killer when investing, especially if you have state taxes on top of your federal marginal rate.

  4. Navtej Kohli says:

    I want to congratulate author of this article for providing the guideline before investing in Mutual fund its be necessary to know how your money will be safe if you are going for company to invest your money in particular mutual fund. Many mutual fund advertise that “Investing in Mutual fund is subject to market risk . please read offer document before investing ” .But its not be clear that how much person go through that announcement and get necessary step. Moreover Navtej Kohli who is always studied about market and fund flow in the market announce to raise his fund in foundation .

  5. rodgerlvu says:

    thanks. you are the most intelligent person i ever met…

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