Don't Look to the (Morning)stars for Investment Advice - Show 139

Thursday, October 30, 2014 4,625 views

A Five-Star rating usually signifies something positive. When a movie gets a Five-Star rating from critics, it’s probably a safe bet it’s going to be a hit. A Five-Star Crash Test rating on a car means it’s built like a tank. A Five-Star rating for a restaurant most likely means your going to enjoy your meal. So when Morningstar, the leading Independent Investment Research company, passes out their Five -Star ratings for mutual funds, you’d think that’d be a slam dunk investment. However, investors should give pause.  

In a recent article published by The Wall Street Journal titled, “Mutual Funds’ Five-Star Curse, ” they looked at 403 Five -Star funds from 10 years ago and what their ratings were today. Please note that we have adjusted the authors’ results for estimated survivorship because they did not account for the funds that had a five-star rating ten years ago but no longer exist today. They did not account for the approximately 21% that were merged or liquidated. 2% are now One-Star funds, 11% are Two-Star, 25% of them are Three-Star, 30% dropped to Four-Star and only 11% maintained their Five -Star status. As you can see, if you started with a Five-Star fund investment 10 years ago, you have about a one-in-nine chance of still having a Five-Star fund today. And furthermore, Morningstar’s Fund Manager of the Decade in 2010, Bruce Berkowitz, followed up that award in 2011 by lagging the S&P 500 by 34.5%.

So if the star rating is unpredictable, what should investors be looking for? Morningstar’s own Russel Kinnel said it best: “If there's anything in the whole world of mutual funds that you can take to the bank, it's that expense ratios help you make a better decision. In every single time period and data point tested, low-cost funds beat high-cost funds.” At I F A , our advisors have been educating our clients on this for years. Don’t look to the stars for your investment advice. Look at the data and time-proven research that Index Fund Advisors has accumulated to help navigate your path to retirement. 

Learn more about the Star Ratings in this article.

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