Do I have to read the prospectus before buying an index fund?

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ebaron
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Do I have to read the prospectus before buying an index fund?

Post by ebaron »

Before buying an index fund, should I read its prospectus from cover to cover? I don't want any surprises, so should I always read 100+ pages for every index fund that I want to buy? How do passive investors conduct comprehensive research? Most people do not have time to read thousands of pages of documents written in legal language.
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Re: Do I have to read the prospectus before buying an index fund?

Post by crswvc »

Should you? Yes
Have to / Required to? No
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ebaron
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Re: Do I have to read the prospectus before buying an index fund?

Post by ebaron »

crswvc wrote: Mon Oct 12, 2020 10:24 am Should you? Yes
Have to / Required to? No
Do Bogleheads do it?
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Re: Do I have to read the prospectus before buying an index fund?

Post by afan »

The Vanguard index fund prospectuses are very much shorter than you indicate. If the fund has a massive propectus, I would worry that it is not a simple cap weighted fund. I would not by an index fund that is not simple cap weighted.

You could find another fund, or try to figure out what this one is doing that requires all that detail. You suggest you are not interested in reading a long document to figure it out. So just buy a simple fund with a simple prospectus.

I would read the prospectus of the fund you choose. How else are you going to know what it says?
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Re: Do I have to read the prospectus before buying an index fund?

Post by Escapevelocity »

It would be far better to spend an hour educating yourself about how index funds operate than to read the legal language in a mutual fund prospectus. If you're dealing with a vanilla type SP500 or Total Market Index fund you just need to understand the nature of the underlying index, the expense ratio and the tracking error that the management has delivered.
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Re: Do I have to read the prospectus before buying an index fund?

Post by Soon2BXProgrammer »

ebaron wrote: Mon Oct 12, 2020 10:27 am
crswvc wrote: Mon Oct 12, 2020 10:24 am Should you? Yes
Have to / Required to? No
Do Bogleheads do it?
I skim a prospectus, to make sure it is what it says it is.

Case in point, did you know the Fidelity ZERO funds can not be transferred to another brokerage? We all talk about moving funds around say to move $100k to BOA to get their premier rewards.. Well, you can't do that with Fidelity ZERO investments in a taxable account. They will not ACAT.
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Re: Do I have to read the prospectus before buying an index fund?

Post by dru808 »

Which index fund has a 100 page prospectus? I read them at some point before or during ownership.
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Re: Do I have to read the prospectus before buying an index fund?

Post by mickeyd »

Why would one invest in something and not read the prospectus and any other literature that is meant to inform?
Last edited by mickeyd on Mon Oct 12, 2020 11:03 am, edited 1 time in total.
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Re: Do I have to read the prospectus before buying an index fund?

Post by livesoft »

ebaron wrote: Mon Oct 12, 2020 10:27 am Do Bogleheads do it?
No, they do not. I last read a prospectus in the 1980s I think. You should read at least 3 to 10 prospectuses in your lifetime. It won't kill you. But after 10 of them, you might only read the ones of unusual non-mainstream investments.
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ebaron
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Re: Do I have to read the prospectus before buying an index fund?

Post by ebaron »

livesoft wrote: Mon Oct 12, 2020 10:53 am
ebaron wrote: Mon Oct 12, 2020 10:27 am Do Bogleheads do it?
No, they do not. I last read a prospectus in the 1980s I think. You should read at least 3 to 10 prospectuses in your lifetime. It won't kill you. But after 10 of them, you might only read the ones of unusual non-mainstream investments.
Doesn't this expose you to the risk of buying something that you would not otherwise buy if you had read the prospectus?
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Re: Do I have to read the prospectus before buying an index fund?

Post by Patzer »

I do if it's something uncommon or that I don't trust (i.e. anything in my workplan).
If it's a Schwab or Vanguard fund, then I don't.
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Re: Do I have to read the prospectus before buying an index fund?

Post by senex »

I flip to the back page of the full (not Summary) Prospectus, and spend 1 minute on the "financial highlights" table. (Usually it is the last page, not always).

I ensure the annual return numbers, expense ratio, dividend & cg distributions, and turnover passes my sniff test.

For an actively managed fund (which I haven't bought in ages), I used to read the first few pages of text about the investing approach.
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Re: Do I have to read the prospectus before buying an index fund?

Post by retiredjg »

ebaron wrote: Mon Oct 12, 2020 10:27 am
crswvc wrote: Mon Oct 12, 2020 10:24 am Should you? Yes
Have to / Required to? No
Do Bogleheads do it?
I don't read them. I do use a prospectus frequently to look things up from time to time - to find out what index the fund follows or what the expense ratio is.

Once you have a good grasp of what an index fund is and how they work, most of what you want to know is plain from the name of the fund. If you want to do comparison shopping between two similar funds/ETFs, you might have to actually read more of the prospectus.
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Re: Do I have to read the prospectus before buying an index fund?

Post by Trader Joe »

ebaron wrote: Mon Oct 12, 2020 10:27 am
crswvc wrote: Mon Oct 12, 2020 10:24 am Should you? Yes
Have to / Required to? No
Do Bogleheads do it?
No I do not. I look at the fund summary information only.
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Re: Do I have to read the prospectus before buying an index fund?

Post by bigmoney »

ebaron wrote: Mon Oct 12, 2020 10:19 am Before buying an index fund, should I read its prospectus from cover to cover? I don't want any surprises, so should I always read 100+ pages for every index fund that I want to buy? How do passive investors conduct comprehensive research? Most people do not have time to read thousands of pages of documents written in legal language.
Will you be have a better understanding of what is going on if you read everything? If yes, go for it.

A consolidated strategy is to understand what the index means, and a general idea of what holdings are in the fund. For example, if you are buying an equity fund, say S&P 500, skim the list of the company stocks you are purchasing via the fund.

Most importantly, you should be aware of risks, potential benefits, and fees involved with your funds, and how they align with your personal goals. If taxable, understand how often you should expect holdings to turn over and when dividends are paid. You don't want to sell during the wash sale period of a dividend payout, unless you don't mind triggering wash sale complications/record keeping on your taxes.
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Re: Do I have to read the prospectus before buying an index fund?

Post by BrooklynInvest »

If I were investing in a narrow sector index kinda thing then I'd make the time to slog through the prospectus on the off chance any of it wasn't written in legalese.

But now that I think of it I could probably find the time to review 'em given I've had the same handful of funds for several decades now ;-)
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Re: Do I have to read the prospectus before buying an index fund?

Post by willthrill81 »

ebaron wrote: Mon Oct 12, 2020 10:27 am
crswvc wrote: Mon Oct 12, 2020 10:24 am Should you? Yes
Have to / Required to? No
Do Bogleheads do it?
As long as it's a 'plain vanilla index fund' like VTSAX, nope. I know how the fund works and the risks involved.

But with more exotic funds like leveraged ETFs or ETNs, it's a really good idea to read the prospectus.
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Re: Do I have to read the prospectus before buying an index fund?

Post by tdmp »

ebaron wrote: Mon Oct 12, 2020 10:27 am
crswvc wrote: Mon Oct 12, 2020 10:24 am Should you? Yes
Have to / Required to? No
Do Bogleheads do it?
I don't.
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Re: Do I have to read the prospectus before buying an index fund?

Post by JoeRetire »

ebaron wrote: Mon Oct 12, 2020 10:19 am Before buying an index fund, should I read its prospectus from cover to cover? I don't want any surprises, so should I always read 100+ pages for every index fund that I want to buy? How do passive investors conduct comprehensive research? Most people do not have time to read thousands of pages of documents written in legal language.
Read enough to avoid surprises, and ensure you are investing in what you intended.
Often the Summary Prospectus will suffice. It's short, and has more plain English than legalize. If that doesn't tell you what you need to know, then at least skim the full Prospectus.
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Re: Do I have to read the prospectus before buying an index fund?

Post by anoop »

Stocks only go up. There is no need to read anything.
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Re: Do I have to read the prospectus before buying an index fund?

Post by nisiprius »

Yes.

Why? Because even though they may sort of conceal this in the form of a simple checkbox, in order to buy a mutual fund you are actually signing a legal document in which you say that you did. Personally I am not willing to fib on legal documents that I sign.

Is this meaningless? No, it isn't. It takes a while to decide how to "read" the prospectus but there really are things to look at. For example (a real one), if a guru says that a certain mutual fund is "passive," but the prospectus says "The Fund is actively managed," that doesn't mean you shouldn't buy the fund but it does mean there is a question you should get answered to your satisfaction before you buy it.

Another example. Every prospectus AFAIK--both the "summary" and "statutory" ones--contains a list of "Principal Risks of Investing in the Fund." For the Vanguard Total Stock Market Index Fund, the summary prospectus lists two:
Principal Risks
The Fund is subject to the following risks, which could affect the Fund’s performance:
  • Stock market risk, which is the chance that stock prices overall will decline. Stock markets tend to move in cycles, with periods of rising prices and periods of falling prices. In addition, the Fund’s target index may, at times, become focused in stocks of a particular market sector, which would subject the Fund to proportionately higher exposure to the risks of that sector.
  • Index sampling risk, which is the chance that the securities selected for the Fund, in the aggregate, will not provide investment performance matching that of the Fund’s target index. Index sampling risk for the Fund is expected to
    be low.
That is the full list of risks and their full descriptions.

The Wisdomtree Emerging Markets SmallCap Dividend Fund is also an index fund; it "employs a 'passive management' or indexing investment approach designed to track the performance of the Index." However, it lists nineteen principal risks, with a paragraph about each one (which I haven't included).
  • Emerging Markets Risk.
  • Small-Capitalization Investing Risk.
  • Dividend Paying Securities Risk.
  • Investment Risk.
  • Market Risk.
  • Shares of the Fund May Trade at Prices Other Than NAV.
  • Capital Controls and Sanctions Risk.
  • Cash Redemption Risk.
  • Currency Exchange Rate Risk.
  • Cyber Security Risk.
  • Foreign Securities Risk.
  • Geographic Investment Risk.
  • Geopolitical Risk.
  • Index and Data Risk.
  • Information Technology Sector Risk.
  • Investment Style Risk.
  • Issuer-Specific Risk.
  • Non-Correlation Risk.
  • Non-Diversification Risk.
You might judge that many of these are trivial, or that you don't even see them as risks. Furthermore, many would choose to take these risks because in investing, you hope to be rewarded for taking risk and they think the benefits outweigh the risks. Nevertheless, you should take the time and make the judgement, particularly with any that aren't already familiar to you. In this particular case, for example, "non-diversification risk" catches my eye.

Also, I would say that the harder it is to find the prospectus on a fund company's website, the more important it is that you actually bother to find it and read it.

That said, big, broadly-diversified mainstream index funds are not likely to have surprises in the prospectus, and looking them over will be something of a waste of time--although it will give you practice in what a straightforward prospectus looks like so that you will be more ready to spot odd things in less-straightforward ones.

I think the summary prospectus is fine. And "read" doesn't need to be taken too literally. It helps to go in with a mental list of "questions I have about this fund" and see if you can find the answers in the prospectus.
Last edited by nisiprius on Mon Oct 12, 2020 1:08 pm, edited 7 times in total.
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Re: Do I have to read the prospectus before buying an index fund?

Post by SmileyFace »

Before I pay a contractor $30K to remodel my kitchen I read the contract.
Before I pay $30K for a car I read everything I can about the car.
Likewise - before I give someone $30K of my hard-earned money to invest - I read the prospectus.
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Re: Do I have to read the prospectus before buying an index fund?

Post by livesoft »

ebaron wrote: Mon Oct 12, 2020 10:58 am
livesoft wrote: Mon Oct 12, 2020 10:53 am
ebaron wrote: Mon Oct 12, 2020 10:27 am Do Bogleheads do it?
No, they do not. I last read a prospectus in the 1980s I think. You should read at least 3 to 10 prospectuses in your lifetime. It won't kill you. But after 10 of them, you might only read the ones of unusual non-mainstream investments.
Doesn't this expose you to the risk of buying something that you would not otherwise buy if you had read the prospectus?
Sure it does. But I am in my 60s and I am not buying non-mainstream investments.

I will say that in 2008 I did exchange into a "Government Securities" bond fund in my employer's 401(k) that was run by Morgan Stanley at the time. It turns out that the prospectus said that up to 20% of the fund could be invested in junk. And Morgan Stanley got caught holding Countrywide bonds, so they unloaded those bonds into that allowed 20% fraction of that Morgan Stanley US Government Securities bond fund in order to save their butts. Unfortunately, their clients and people who had that fund in their 401(k) were screwed. That bond fund dropped more than 10% in a few weeks.
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Re: Do I have to read the prospectus before buying an index fund?

Post by yangtui »

The several funds that I own have all been thoroughly discussed and torn apart on this forum. I trust the analysis here far more than what it probably contained in the prospectus. I suppose if I was going to buy something novel I would read the prospectus.
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Re: Do I have to read the prospectus before buying an index fund?

Post by UpperNwGuy »

mickeyd wrote: Mon Oct 12, 2020 10:50 am Why would one invest in something and not read the prospectus and any other literature that is meant to inform?
Because they’re boring.
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Re: Do I have to read the prospectus before buying an index fund?

Post by Nate79 »

Most of my money is in a 401k with CIT funds that all I get is a one page fund fact sheet. I've read that. I've also read a number of, but not all a few samples of annual reports of a few funds we own. But I see zero reason for the average investor to read the fund prospectus of a major index fund from a major provider. The basic information is shown online in the funds website.
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Re: Do I have to read the prospectus before buying an index fund?

Post by patrick »

nisiprius wrote: Mon Oct 12, 2020 12:44 pmEvery prospectus AFAIK--both the "summary" and "statutory" ones--contains a list of "Principal Risks of Investing in the Fund." For the Vanguard Total Stock Market Index Fund, the summary prospectus lists two:
Principal Risks
The Fund is subject to the following risks, which could affect the Fund’s performance:
  • Stock market risk, which is the chance that stock prices overall will decline. Stock markets tend to move in cycles, with periods of rising prices and periods of falling prices. In addition, the Fund’s target index may, at times, become focused in stocks of a particular market sector, which would subject the Fund to proportionately higher exposure to the risks of that sector.
  • Index sampling risk, which is the chance that the securities selected for the Fund, in the aggregate, will not provide investment performance matching that of the Fund’s target index. Index sampling risk for the Fund is expected to
    be low.
That is the full list of risks and their full descriptions.

The Wisdomtree Emerging Markets SmallCap Dividend Fund is also an index fund; it "employs a 'passive management' or indexing investment approach designed to track the performance of the Index." However, it lists nineteen principal risks, with a paragraph about each one
Checking the portfolios of these two funds shows the peril of relying on prospectuses to inform about risk:

28% of Vanguard Total Stock Market Index Fund is in information technology
22% of Wisdomtree Emerging Markets SmallCap Dividend Fund is in information technology

Yet only the Wisdomtree fund lists "Information Technology Sector Risk" as a principal risk. Checking for "Information Technology Sector Risk" in the prospectuses leads to the wrong conclusion about which fund has more concentrated exposure there.
Last edited by patrick on Mon Oct 12, 2020 3:21 pm, edited 2 times in total.
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Re: Do I have to read the prospectus before buying an index fund?

Post by TheDDC »

1. A better question would be: Do I have to understand the prospectus before buying an index fund?

2. A follow up would be: How many on this forum could explain, line by line, the prospectus to their favorite index fund?

My guess would be:

1. No

2. Maybe 10%

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Re: Do I have to read the prospectus before buying an index fund?

Post by nisiprius »

livesoft wrote: Mon Oct 12, 2020 2:45 pm...It turns out that the prospectus said that up to 20% of the fund could be invested in junk...
Unfortunately, it is very, very common, if not universal, for the prospectus to contain language like this, from the Statutory prospectus for Total Stock
Under normal circumstances, each Fund will invest at least 80% of its assets in the stocks that make up its target index.
The percentage always seems to be "80%." Now my personal opinion is that this sucks.

Then, too, this is only under "normal" circumstances--and elsewhere the Vanguard prospectus notes that "Vanguard reserves the right to change its policies without notice to shareholders!"

It's necessary to look at the annual and semiannual reports and other holdings disclosures to get some idea of what the fund is truly investing in. In the case of many funds, it turns out that when you look at the holdings, the percentage invested in The Stuff You Thought It Was Invested In is much much higher than 80%... 1% here in cash, 0.2% there in mysterious derivatives, 0.1 in "other," but you know, 98% in what you thought. The June 30, 2020 semiannual report for Total Stock says that it has "0.0%" in preferred stocks! In this case, $3,296,000 out of $867,925,992,000 = 0.00038%. Did I do that correctly? I thought I had basic numeracy but I would not have guess that $3 million worth of preferred stocks would round to 0.000%!

At one point the Fidelity [Spartan] Total Market Index Fund had about 4% invested in international stocks, but, you know, still over 95% in US stocks...
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