Investing Advice

Rating Systems at Morningstar

Since 1985, a company named Morningstar has provided investors with its rating system, assigning one to five stars to funds. You will see these stars in all the mutual fund ads.

To determine the number of stars to award a fund, Morningstar scores a fund for risk. Then it subtracts that figure from the fund’s five-year return to get a risk-adjusted rating.

The top 10% of funds get 5 stars, the next 22.5% get 4 stars, and the next 35% 3 stars, the next 22.5% 2 stars, and the bottom 10% get just 1 star.

How well does this rating system work and should you pay attention to it? With the exception of index funds where the rating is meaningless, rating a fund based on its past performance is just looking in the rearview mirror.

Morningstar’s top-rated 5 star funds in 1991, 1992, and 1993 fell behind the general market for the next 8 years by an average 3%. They couldn’t even match the performance of the S&P 500.

Morningstar is currently revising their rating system to improve its usefulness.

Another company, Lipper Inc, has provided mutual fund analysis to institutions since 1971. They give investors a good alternative way of rating funds. Lipper, mindful of investor’s interest in capital preservation, ranks funds with a downside-only view of performance risk. Funds rated with a “one” have the least chance of losing money.

Lipper’s web site at www.lipperleaders.com also measures a fund’s after-tax return, fees and expenses, and total return.

Other Stock Market Basics Topics:

  1. Mutual Fund Advantages
  2. History of Mutual Funds
  3. NAV
  4. Dollar Cost Averaging
  5. General advice about choosing a fund
  6. Mutual Fund Ratings
  7. Evaluating Mutual Fund Investment Risk
  8. Mutual Fund Share Classes
  9. Mutual Fund Fees
  10. The Mutual Fund Prospectus
  11. How important is the manager's length of experience?
  12. Why is the prospectus hard to understand?
  13. Mutual Fund Annual Report
  14. Comparing your fund to the competition
  15. Comparing funds on an after-tax basis
  16. Average Return on Investment
  17. How Not to Pick a Mutual Fund
  18. Cashing in Your Fund
  19. When to Sell Your Fund
  20. Mutual Funds and Asset Allocation
  21. When to get started with a mutual fund
  22. Types of Mutual Funds
  23. Value Stock Funds
  24. Growth Stock Funds
  25. Small and Micro-cap Stocks
  26. Mid Cap
  27. Large Cap Companies
  28. Income Stock Funds
  29. Mutual Fund Index
  30. Enhanced Index Funds
  31. Sector Mutual Funds
  32. Stock Market Sectors
  33. Defensive Stocks
  34. International Funds
  35. Real Estate Mutual Funds
  36. Socially Responsible Funds
  37. Balanced Funds
  38. Tax-Efficient Funds
  39. Bond Convertible Funds
  40. Junk Bond Funds
  41. Mixtures of stock types
  42. Closed End Funds
  43. Exchange Traded Funds (ETF’s)
  44. Stock Picking Strategy - Picking your own stocks?
  45. Fund names, and what they really invest in
  46. How to get started
  47. Where can I start investing with no money?

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