What Do Mutual Fund Ratings Involve? By Christopher Smith At Isnare.com Ezine Articles

Investors who want to limit or reduce their risk usually elect mutual funds. Mutual funds are a diversified group of bonds, money market securities or stocks that generate returns from more than one source. Thanks to their diversification, the risk involved is reduced or limited. Mutual fund ratings are used to aid successful investors conclude which funds are best for them, based on the measure of risk that is involved. Different companies determine the fund rating based on their own criteria.

Morningstar

Morningstar has been rating funds since 1985. They award 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.

This company has been analyzing funds and helping investors select the best mutual funds for them since 1971. Lipper ranks funds based on performance risk, but is based on poor or risky performance meaning that the higher the risk, the higher the rating. The lower the risk, the less chance the investor has of losing money. Lipper has a five point rating system that includes five different criteria (total return, consistent return, preservation, tax efficiency and expense) to help determine the actual risk of a fund.

Business Week

Their Mutual Fund Scoreboard is carried annually in their magazine, but savvy investors can access that scoreboard at any time by going to Business Week's website and accessing the Mutual Fund Scoreboard, which is updated monthly. They rate funds on quite a few different criteria, but they obtain the overall rating by assessing the performance over a five year period, based on risk adjusted returns. They deliver the ratings in a letter grade with A being superior and F being very poor.

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.

The wise investor will not rely on only one rating system, but, in fact, several in order to obtain a clear picture of a mutual fund's risk factor. While past performance of a fund may shed a little light on the fund's risk factor and viability, future performance can not be predicted based solely on this criteria. A complete picture of the company and the fund must be obtained in order to fully assess the potential risks and strength of the fund. Even then it is not an exact science and there are no guarantees.

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