Now that we’ve covered how to buy and sell mutual funds, let’s talk about mutual fund ratings and how they’re calculated.
What are mutual fund ratings?
Mutual fund ratings assess how the fund has performed over a period of time. The ratings are obviously helpful and important to investors – they allow them to get a quick opinion on a fund within minutes. Rating agencies keep fund managers on their toes and provide a super valuable service to customers.
Mutual fund ratings providers help keep fund companies honest by providing reviews on mutual fund boards, looking at the backgrounds of portfolio managers, detailing whether a fund is remaining true to its investment style, etc.
How mutual fund ratings are calculated
These are the two biggest fund-rating systems:
The Morningstar Rating System
Morningstar uses a ranked system with stars as the rating standard. The system presents breakdowns for equity funds into 12 industry groups inside three primary economic sectors to compare weighting decisions.
The Lipper Rating System
Lipper provides mutual and hedge fund reviews as well as commentary and tools for analyzing data. Lipper services the institutional and asset management industry, but its mutual fund services are still provided in detail for retail investors of all levels. Lipper Leaders, the rating system, covers 80,000+ funds. It uses a numbered rating system from 1 to 5; based on consistency, capital preservation, peer performance and expense management, etc.
Disadvantage of Mutual Fund Ratings
It’s easy to fall into the "performance trap” by blindly chasing performance. Past mutual fund returns are really not a great indicator of future performance. It’s also important to be weary of the herd mentality that often comes with mutual fund investing.
During volatile market times, mutual funds managers are susceptible to any temptation to try to increase performance. They may also attempt to protect themselves against downside risk. Both of these factors can lead to rogue trading - or even fraud.
Selecting mutual funds and reading their ratings can be pretty overwhelming – we know. We’ve got you covered. Our Putting Your Money in the Market course will teach you everything you need to know about picking mutual funds.