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What Fund Rating System Should I Use?

QUESTION: It seems that there are hundreds of different rating systems for mutual funds. Are there one or two rating systems that are preferred over all of the others? I look at one system and find their best large cap growth funds are different from another’s. How is an independent investor to decide?

–David Hippensteel, St. Francis, Wis.

ANSWER: You’re right that different fund raters emphasize different factors, and often end up recommending different funds. Morningstar’s system is the most widely used, but Lipper benchmarks are often used internally to gauge manager performance. Morningstar gives funds one to five stars based on a performance over the past three, five, and ten years compared to other funds in the same category. The system also takes volatility and expenses into account. Lipper has a similar one-to-five rating that compares funds to their peers, but it offers five different “Lipper Leader” ratings, including on Total Return, Consistent Return, and Expense.

Such rating systems should only be the starting point for fund research, says Charles Rotblut, vice president of the American Association of Individual Investors. Check out the fact sheet and prospectus offered on the fund’s website for a look at what it owns and a description of its investing strategy. You’ll want to know if the fund’s manager tends to make big bets on a particular industry or takes a more diversified approach, for example.

Of course, magazines like SmartMoney and investor newsletters also apply their own screens to search for promising funds. Remember to keep an eye on fees — research has shown that fees are actually the best predictor of future performance.

For more:

How to Choose a Stock Mutual Fund

How to Choose a Bond Fund


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    • exchange traded funds list – Find the best funds for you with Jemstep’s free online investment advice & portfolio management software.

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      The major recommendation systems provide different perspectives, all of which can be useful to the investor. Like the previous commenter, I am presenting a system from my company, FundRevealSM. The FundReveal approach is objective and quantitatively based. It explicitly includes all 20,000 funds available in the US, unlike Morningstar.
      I am not sure of the universe covered by Jemstep.

      FundReveal predicts top mutual fund performance by understanding the quality of Investment Decision-Making Capability (IDMC). The recent demonstration of the power of FundReveal predictive capability has drawn the attention of individual investors and advisors. FundReveal top funds outperformed the S&P 500 between 2001 and 2010: FundReveal 74% cumulative total return, S&P 500 -9%.

      Morningstar adds predictive capability in their soon to be released forward-looking Global Analyst Ratings identify funds with high potential for future performance based on subjective analysis. FundReveal provides a broad objective counterpoint to the qualitative Morningstar ratings. And, by including the entire US mutual fund universe, FundReveal provides market context for the Morningstar view of 1500 covered funds.

      A comparison of the new Morningstar service and FundReveal is available on the FundReveal blog.

    • Jemstep (disclaimer: I work there) provides personalized rankings of funds, using a patented technology that analyzes 20k+ funds against the investor’s unique profile – defined by their goals and preferences. It’s a free online tool – And while my comment here is biased, the recommendations are not, since they are entirely data-driven.

      The problem with those generic rating systems, like Morningstar and Lipper, is that they attempt to be a “one size fits all” approach. Investors come in all shapes and sizes – with different goals, positions, and risk tolerances, among other preferences. Someone nearing retirement (at the age of 60) should most likely not act on the same investment advice as someone just starting to save for retirement (at the age of 25).

      So while Morningstar’s ratings are based on a generic system that is weighted mostly on past performance, volatility, and expenses, Jemstep bases the weightings of different data points on the relative importance of how each data point aligns with your investment objectives. Then using those weightings, Jemstep presents you with a ranked list of the funds that will best help you reach your goals. Also unlike Morningstar, Jemstep provides direct comparisons between our top-ranked funds and any funds you currently hold, so you can see how your holdings measure up. You can also easily compare our top-ranked funds with any other funds you may be interested in.

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