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Can You Trust Morningstar 5 Star Mutual Funds?

February 28, 2012 | Comments: 0 | Views: 265

Morningstar's 5 star mutual funds are typically regarded as the best of the best in terms of investments. But is it really so simple that you can trust Morningstar's rating blindly? People want to be assured that the fund they're going to be investing in is a winner, and with the way that companies proudly wave their 5 star flag high, it only makes sense that people would be drawn to them. However, 5 star mutual funds might not automatically be for you. A simple rating is nothing like an in-depth review of the fund's history, or a closer look at the manager.

Morningstar's Rating System

While it's highly unlikely that 5 star funds would ever lead to failure, there is more to preparing for investing than just finding a fund with a good rating. Morningstar has even given a statement explaining their system: "Morningstar's fund star rating is designed to give investors a quick snapshot of how a fund has balanced risk and return in the past. We calculate a fund's star rating relative to other offerings that operate within the same category." What the company does is take the past performance number for a fund and then make calculations according to the risk level of the fund.

The Drawback Of Morningstar

Morningstar has a good 80 or so different categories for their funds, from the common to the extremely rare. In each category, it sorts the funds it has review from best to worst, starting at the bottom and going up. This makes the top 10% of every category the best of the bunch, the 5 star mutual funds. The following 22.5% receive four stars. And while these ratings can be very promising, putting money into a fund based solely on its Morningstar rating can be problematic. For instance, there are many funds that don't fit very well into just one category, but of course, Morningstar gives them one. While they may be just fine on their own, compared to other funds in the category -- which is how Morningstar does their ratings, through comparison against peers -- it may end up with a two-star rating.

Do Your Own Mutual Funds Research

When it comes to putting your money down on something, you shouldn't make your decisions based on just a recommendation. And that's what Morningstar's ratings are: recommendations on 5 star mutual funds from the company. While Morningstar's ratings can definitely be helpful, blind faith is not. Be sure to always do your research before committing to an investment.

Connor Swinney is the owner of the What Are Mutual Funds website. He created the website to be used as a resource for people who are looking for more information on How Mutual Funds Work or that would like to know how they can create a successful investment strategy.

Source: EzineArticles
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