Reading the Prospectus...A tutorial about knowing what you are invested in.

You can know the name of a bird in all the languages of the world, but when you're finished, you'll know absolutely nothing whatever about the bird... So let's look at the bird and see what it's doing -- that's what counts. I learned very early the difference between knowing the name of something and knowing something. -Richard Feynman

With the current downturn of the economy, many people are uncertain about their future with the current financial situation that the country is facing. If you were fully invested in stocks since October 2007, your portfolio is probably down somewhere in the neighborhood of 30% - 40% of its value on that date. It is amazing the difference a year can make.

I must admit, I have fell victim to the downturn of the stock market just as many of my colleagues have. As of today, I am currently down 38.8% in my 401(k) alone not to mention the many other investments that I currently own. While I am in no position to make a recommendation on what to invest in next, what I can do explain the tools provided for the investor that can help you make an informed decision about where to place your hard earned money.

Some of the fundamental steps that is incorporated in "It's Easy as P.I.E" is the planning and evaluation phases. Both of these require that you do the necessary research to make sure that your current allocation is the best applicable to your current financial situation. It also requires that you periodically review your current allocation to make sure that your portfolio is best suited for the amount of risk you are willing to take on. One of the most important tools for doing this research for a stock or mutual fund investment is given in the form of a prospectus.

Prospectus: A formal legal document, which is required by and filed with the Securities and Exchange Commission, that provides details about an investment offering for sale to the public. (Link to Investopedia)

Prospectuses are usually broken down in the following structure:

1. Overview
• Typically provides a high level overview of what the stock or fund is comprised of.
• May provide a small summary of the objectives of the company and how they plan to make their revenue.
  
• Provides some general information about the investment and provides in general a snapshot of the investment Year to Date (YTD) performance and price.
  
2. Expense and Fees
• In the case of mutual funds, there is usually a management fee that the mutual fund charges you in order to maintain the fund purchased. This fee is usually referred to as the Expense Ratio.
• Expense Ratio: A measure of what it costs an investment company to operate a mutual fund. An expense ratio is determined through an annual calculation, where a fund's operating expenses are divided by the average dollar value of its assets under management. Operating expenses are taken out of a fund's assets and lower the return to a fund's investors. (Link to Investopedia)
• Some funds also contains a load fee that is charged for maintaining the fund.
• Load: A sales charge or commission charged to an investor when buying or redeeming shares in a mutual fund. (Link to Investopedia )
  
• May also contain a minimum amount required to purchase the fund initially. From my own experience, it does not look like this minimum price needs to be maintained, but just done on the date of the initial purchase of the fund.
  
3. Performance
• This section may be the most important part of the prospectus as it will generally give you an idea of what kind of return you will be able to get on your investment.
• Contains average annual returns for 1, 3, 5 and 10 years. May contain the funds performance since the fund's inception.
• Return: The gain or loss of a security in a particular period. The return consists of the income and the capital gains relative on an investment. It is usually quoted as a percentage.(Link to Investopedia)
  
• The use of the return helps gauge future performance of the fund or stock. Depending on the market conditions, it can allude to whether or not the investment is going to continue to provide a good return on your investment or whether you should look elsewhere as it might have hit its peak.
• Usually represented in a percentage form that displays your overall return in the case that the investment was made at whatever previous time period without further contributions.
  
• This section may also contain a graph of the prices of this investment over time for a predetermined time period allowing for an example of what a certain amount of money would have returned over the past.
  
4. Portfolio Composition
• Another very important section to the prospectus is the portfolio composition.
• Contains information about the specific stocks or other mutual funds and the amount of them that the investment is comprised of.
• In a mutual fund, usually contains a list of the Stock Style
• Stock Style: The investment approach or objective that a fund manager uses to make choices in the selection of securities for the fund's portfolio. (Link to Investopedia)
• Flash Movie of Stock Styles
• Displays the sectors of the market that the fund is exposed to.
5. Prices and Distributions
• This section contains a historical reference of the prices that the stock or mutual fund closes at on a daily basis.
• Can be useful for determining whether a stock is over-valued based on the price over a given period of time.
  
• Can also help to identify the best time to purchase the stock during the month.
• Contains the rolling 52 week high and low which allows you to gauge the high price and low price for the year of the investment.
  

Although I am unsure about how much lower the Dow Jones will go, I am still hopeful that the stock market will rebound and pull itself out of this funk. In my opinion, I think that there will be a lot of bad days down the road, however, if I am able to make an informed decision by investing in the sectors that I believe will bring America back to the forefront of the global economy, I may be able to reap some great rewards.

Feel like I missed something in this article about prospectus? Please share your knowledge about this topic in the comments below.

Stay Disciplined!

P.S. - For some real world examples of prospectuses, look at the links below:

Fund listing for Vanguard
Fund listing for TRowePrice