When your broker or financial advisor recommends that you read an investment or fund prospectus, it’s for a good reason. A prospectus can offer clues to help you assess an investment’s risks.
“Carefully consider the investment objectives, risks, charges, and expenses before investing. The prospectus contains this and other important information. Read carefully before investing.”
This is the standard boilerplate language you might see when considering an investment—a mutual fund, exchange-traded fund (ETF), stock, or bond, for example. Not coincidentally, the word prospectus is tied to the Latin root for “to view” or “look forward.”
Here’s another Latin lesson: caveat emptor. For investors, the prospectus provides a critical “buyer beware” reminder and guidebook for making sure you know what you’re getting into. It may not be your idea of light reading, but don’t let anyone tell you to dismiss these documents as a bunch of legal jargon to just skim through before you hand over your money.
Prospectuses contain clues that can help investors gain a firmer grasp on a company or fund’s management, strategy, and longer-term prospects, according to Viraj Desai, senior portfolio manager at TD Ameritrade Investment Management, LLC.
“A careful reading of the prospectus can help investors understand some of the risks of investing to make a more prudent investment decision,” Desai said. Here are a few investor basics on prospectuses.
A prospectus is an official company document that describes basic financial and business information. In your investing journey you’re likely to come across two distinct types. Though each differs in terms of the type of information included, the general purpose is the same—to inform potential investors of risks and other important information.
Company prospectus. A company that is offering securities for sale—such as before an initial public offering (IPO) or bond issuance. For publicly traded U.S. companies, or companies planning to sell shares in an initial public offering (IPO), prospectuses are available on the Securities and Exchange Commission’s (SEC's) online EDGAR platform. Many company prospectuses are contained in a form S-1, which is a registration statement under the Securities Act of 1933. You can also get a prospectus from a company’s website.
Fund prospectus. A fund prospectus—for a mutual fund or ETF for example— provides information about the fund’s costs, investment objectives, risks, and performance. Typically, each fund family has a prospectus available for each individual fund. You can also get one from your broker or other financial professional. TD Ameritrade clients can see the prospectus of any fund it offers. See figure 1 below.
In addition to basic financial details such as revenue, profit, and expenses, a prospectus can include:
A prospectus sometimes makes news, especially if it’s from a high-profile, fast-growing startup with a widely anticipated IPO in the pipeline.
Uber Technologies, for example, detailed a number of items that are likely of interest to investors in its 300-page S-1 filing in April 2019. It included 2018 revenue ($11.3 billion), trips taken by the ride-hailing company’s users (1.49 billion in the fourth quarter), and a letter from CEO Dara Khosrowshahi (explaining that Uber is a “once-in-a-generation company, and the opportunity ahead is enormous”).
A company prospectus can also offer clues as to potential red flags. Is the company making or losing money? Sometimes it’s in the eye of the beholder. You might watch for terms like “adjusted EBITDA” and other terminology involving how the company defines its net income or losses. Also, scour a prospectus for details on a company’s business plan, risks of all varieties (natural disasters, recessions, geopolitics, etc.), and how it may award executives with shares or options.
TD Ameritrade tools and services can help you decide.
According to Desai, a fund prospectus outlines the parameters of a fund’s investment strategy and mechanics of the investment vehicle. A fund prospectus actually comes in two forms: statutory and summary.
The statutory prospectus is the traditional, long-form disclosure. The shorter summary prospectus is often just a few pages long and contains key information about a fund, but fewer specifics, and sometimes less legalese. Both, however, contain important information, including the fund’s investment objectives or goals, strategy, principal risks for investors, fees and expenses, and past performance.
“Mutual funds must provide a copy of the fund’s prospectus to shareholders after they purchase shares, but investors can—and should—request and read the fund’s prospectus before making an investment decision,” the SEC said on its website.
For mutual fund investors, prospectuses outline critical “parameters and guardrails the fund and its management team are committing to operate against,” Desai emphasized.
Careful review of the prospectus, Desai said, can highlight several classes of risks, such as the use of leverage or derivatives, diversification (or its lack), and other areas. “The prospectus will highlight in some cases the qualifications of lead investors so that clients can confirm that assets they delegate will be managed by an experienced team.”
In a mutual fund prospectus, investors “should keep an eye out for anything that could disrupt the going concern of the fund,” Desai said. “Low tenure of portfolio managers is worth investigating to see if turnover might be an issue or if the team is adequately experienced.” Other red flags, Desai added, could include an overly complicated investment strategy, a longer-than-average list of potential risks to investors, or “excessively complex” fee schedules.
Investing in today’s markets can sometimes feel like a double-edged sword. On the one hand, the sheer number of investment alternatives, combined with accessible and easy-to-use platforms, makes investing a few clicks or taps away. But before you invest, you need to do your homework. And yes; that means following the prospectus disclaimer: Read carefully before investing.
for thinkMoney ®
Financial Communications Society 2016
for Ticker Tape
Content Marketing Awards 2016
Inclusion of specific security names in this commentary does not constitute a recommendation from TD Ameritrade to buy, sell, or hold.
Mutual funds, closed-end funds, and exchange traded funds are subject to market, exchange rate, political, credit, interest rate, and prepayment risks, which vary depending on the type of mutual fund. Fund purchases may be subject to investment minimums, eligibility, and other restrictions, as well as charges and expenses. Certain money market funds may impose liquidity fees and redemption gates in certain circumstances.
Carefully consider the investment objectives, risks, charges, and expenses before investing. A prospectus, obtained by calling 800-669-3900, contains this and other important information about an investment company. Read carefully before investing.
ETFs can entail risks similar to direct stock ownership, including market, sector, or industry risks. Some ETFs may involve international risk, currency risk, commodity risk, and interest rate risk. Trading prices may not reflect the net asset value of the underlying securities. Commission fees typically apply.
Market volatility, volume, and system availability may delay account access and trade executions.
Past performance of a security or strategy does not guarantee future results or success.
Options are not suitable for all investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial losses. Options trading subject to TD Ameritrade review and approval. Please read Characteristics and Risks of Standardized Options before investing in options.
Supporting documentation for any claims, comparisons, statistics, or other technical data will be supplied upon request.
The information is not intended to be investment advice or construed as a recommendation or endorsement of any particular investment or investment strategy, and is for illustrative purposes only. Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.
This is not an offer or solicitation in any jurisdiction where we are not authorized to do business or where such offer or solicitation would be contrary to the local laws and regulations of that jurisdiction, including, but not limited to persons residing in Australia, Canada, Hong Kong, Japan, Saudi Arabia, Singapore, UK, and the countries of the European Union.
TD Ameritrade, Inc., member FINRA/SIPC. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. © 2019 TD Ameritrade.