What Do Mutual Fund Ratings Involve?
By Christopher Smith
Investors who want to restrict or reduce their risk usually opt for mutual funds. Mutual funds are a diversified group of bonds, money market 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 assist smart investors conclude which funds are perfect for them, based on the extent of risk that is involved. Different companies determine the fund rating based on their own criteria.

Morningstar
Since 1985, Morningstar has been one of the premier mutual fund rating services. By assigning a rating of 1 to 5 stars, they have guided investors who have been looking for an edge for over 2 decades now. Starting with the company's risk score, the fund's 5 year return is then subtracted, resulting in a risk adjusted rating score. Of course, the problem is that the rating is highly biased to past performance and does not accurately reflect the current risk of the company. So while Morningstar is good at helping you determine which funds have a good track record, it doesn't help to determine which funds will do well in the future.

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 (consistent return, preservation, tax efficiency, expense, and total return) which helps to determine the real risk of the 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.

As a smart investor, you shouldnt 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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