A prospectus is a document required to be filed by the fund by the Securities and Exchange Commission which details certain information regarding the operation and investments of the fund, as well as its philosophies and the limitations on any investment set by the fund. Deviation from or misrepresentation in a prospectus carries with it a significant civil and criminal penalty if enforced by the Securities and Exchange Commission, or a private investor who believes they were defrauded by a prospectus. Investors should always read the prospectus from cover to cover to determine whether the fund is right and in line with the goals of the investor. Each fund will advise the investor to do this, although it is typically not done by an investor.
The reasons for not reading the prospectus in its entirety is that the average investor does not have the knowledge to read sophisticated balance sheets, priced earnings ratios, and other types of financial information. Also, fund managers and prospectus preparers are usually adept at hiding negative information in the prospectus such that, if questioned, the information would appear in the prospectus, and not be a misrepresentation, although an average investor might miss the valuable or needed information. Also, quarterly reports in returns must be prepared by the fund family, and these should be obtained by any investor also. The total return on a fund is made up of share price exchanges, dividends and capital gains. You should check to make sure that your fund pays dividends, reports its capital gains properly, and that you are able to obtain share price changes. Some funds may be so small that they may not be published in The Wall Street Journal or similar sources, and one must call the fund family for a price on the fund. Beware that the information regarding such a small fund might be limited and might severely hamper the ability of the investor to evaluate the fund as a prospective investment. Because dividends are paid by stocks, dividends are passed through to investors who own mutual funds, because theoretically the mutual fund owners own the stocks. Earnings by mutual funds can usually be paid in the form of cash directly to you, or reinvested as shares in the mutual fund.