How are mutual funds and ETFs rated?

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Fund ratings make comparing mutual funds easier

When deciding where to eat, it’s helpful to first look at apps like Yelp and Foursquare, which provide reviews and restaurant ratings. Rather than having to try every restaurant yourself, comparing restaurants based on a single number can save you a lot of time — and extra pounds. Similarly, when comparing mutual funds and ETFs, one way to begin the process is by reviewing each fund’s rating.

Many investors look to Morningstar

While there are many companies that produce fund ratings, Morningstar is the most prominent. Their “star rating” is a quantitative measure calculated from a fund’s past performance. It ranges from one to five stars, with one being the poorest rank and five being the best, and is a comparison against similar funds. In order to receive a rating, a fund must have existed for a minimum period of time — typically 3 years. Any investor can look up a ticker on their website and, assuming the fund has been around long enough, find ratings information.

A single rating may not tell the whole story

However, like restaurant ratings, these are helpful starting points, but one number alone doesn’t tell the whole story. For instance, these ratings are purely backward-looking and only consider performance and fees. Other factors that may affect future performance such as changes in the management team, whether the funds adhered to their stated strategy, and how the market environment may affect the fund, can’t be gleaned from a rating alone. For investors who need additional information, or the judgment of a professional fund analyst, there are many sources and companies which provide this research (i.e., Bloomberg, Lipper Leaders, and MAXfunds,).

Your goals matter when choosing a fund

Additionally, a fund’s rating doesn’t speak to how appropriate it may or may not be for any individual investor. For instance, when looking for a good dessert spot, it’s probably not a good idea for someone who is lactose intolerant to eat at the highest-rated ice cream parlor. Similarly, it may not be appropriate for an investor in retirement, who primarily needs income, to invest in a risky growth fund, even if that fund is highly rated. As always, it’s important to consult a professional before making investment decisions.

Find the right fund for you

Investing in funds can be daunting due to the thousands of potential options. By using tools such as fund ratings, investors can narrow down their lists of options to those that make sense for their particular needs and goals.

** This article should not be construed as a recommendation or an advisement as to the suitability of purchasing a security or securities in general. Your individual needs may vary, and such ratings may not be an appropriate analytical mechanism for your particular financial situation. If you have questions about your investment portfolio, you should consult an investment professional.

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