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What Do Mutual Fund Ratings Involve?

Investors who want to restrict or reduce their risk normally select mutual funds. Mutual funds are a diversified group of money market securities, equities or bonds that create returns from more than one source. However, thanks to their diversification, the risk involved is reduced or limited. Mutual fund ratings are used to aid active investors estimate which funds are perfect for them, based on the degree of risk that is involved. Different companies determine the fund rating based on their own criteria.


Morningstar has been rating funds since 1985. They accord one to five stars to several funds and use it as a guidance method for their investors who are looking to enhance their portfolio. The rating system is based on the company’s initial risk score of the fund. They then subtract that score from the five year return of the fund and arrive at a rating that is risk adjusted. The problem here is that the rating system is based on past performance and has little value in determining the actual risk factor of the fund. This is probably not the most reliable source of determining future risk of your funds.

Lipper, Inc.

Older than Morningstar by almost 15 years, Lipper has been providing analysis for investors since 1971. Based on performance risk, each fund is assigned a rating based on the chances of an investor losing their money. The higher the rating, the better the odds of losing money. This 5 star rating system also factors in five different criteria (tax efficiency, expense, and total return, consistent return and preservation) which helps to determine the real risk of the fund.

Business Week

Subscribers of the Business Week magazine are treated annually to the Mutual Fund Scoreboard, which rates funds on several criteria. Looking for something more current? Check out their website where you can find the results updated monthly. The funds earn their rating by their scoring in different areas, but get their overall rating by how well they have performed over a 5 year period, based on a risk adjusted return. Each fund is then assigned a grade score from A to F. Its the A rated funds that you should consider for your portfolio.

Schwab Mutual Fund OneSource Select List

Schwab’s experts have created a list of pre-screened, no load, no transaction fee funds. This list is updated quarterly and utilizes a list of strict criteria to arrive at the ratings. These criteria include a minimum three year performance track record and have a minimum of $40 million in assets (in most cases). The funds that make the list are rated on risk, performance, diversification and other factors.

As a smart investor, you shouldn’t rely on just one fund rating system. Instead, consider using several different systems to determine the best one for you. Past performance is helpful in establishing how well the fund has performed compared to the major indexes, but is useless unless used in conjunction with other variables. Assess the risks, get a picture of the strength of the fund, specifically the mutual fund manager. While a high mutual fund rating may guide you in the right direction, its by no means a sure bet. Do your due diligence.

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