What we'll cover
What a company's prospectus is
How to use a security's prospectus
Stock vs. mutual fund prospectus
It's crucial to gain knowledge any time you consider investing in a security — especially if a company is new to the market and making their initial public offering (IPO). You might cruise the internet for info, but to really get in the know, read its prospectus. Note that you can find a prospectus for most individual securities (exchange-traded funds or mutual funds, for instance), not just stocks.
What is a prospectus?
A prospectus is a document required by the U.S. Securities and Exchange Commission (SEC) that describes what the security is and outlines the level of risk associated with making an investment in it.
A prospectus must outline all opportunities, risks and financial details about the company that's selling stock to the public. It includes information about the company's history, management team, financial performance and intended use of funds.
A company's prospectus is available to anyone, including investors, regulators and any other interested parties.
Read more: Steps to take to buy your first stock
Where to find a prospectus
One way to locate a prospectus is to visit the SEC's Electronic Data Gathering, Analysis and Retrieval (EDGAR) database.
Search for a specific prospectus using the company or mutual fund name, ticker symbol, filing date or their central index key (CIK). In addition to the prospectus, you can access a company's annual reports, including financial statements, through EDGAR.
You may also request a company's prospectus through your broker or by contacting the company's investor relations department. Some companies provide either a direct link to their prospectus or a prospectus request form on their website.
How to read a prospectus
The prospectus is designed to help you assess if a new investment is right for your goals, risk tolerance and current investment portfolio.
Ask yourself: Does the investment compliment your existing portfolio holdings or simply replicate something you already own?
At the top of a prospectus, these important details are laid out in the summary section:
How many shares of the stock the company plans to sell
The price the company plans to sell the stock
Why the company is looking to sell stock
The management team's broad business objectives
Once you understand the company's business model and goals, you'll want to carefully look at the risk factors the prospectus lays out. Do they align with your risk tolerance? Or is the company riskier than what you're willing to take on?
Consider whether there's any overlap between the security or the prospective fund and your current investments. Ask yourself: Does the investment compliment your existing portfolio holdings or simply replicate something you already own?
How do a stock prospectus and a mutual fund prospectus differ?
Mutual funds are also required by the SEC to file a prospectus (as are exchange-traded funds). Unlike a stock prospectus, a mutual fund prospectus:
Likely includes information about the fund's investment goals and strategies to pursue them
Discloses the fund's fees and expenses and its past performance
Includes the fund's performance and risk as a comparison to a benchmark, like the S&P 500
A good starting point
Before putting any money in the market, it's a good idea to review a prospectus to make sure the stock or mutual fund you're considering is a good fit for your individual investing goals.
