Investors who want to limit or reduce their risk usually embrace mutual funds. Mutual funds are a diversified group of bonds, money market securities or stocks that generate returns from more than one source. Due to their diversification, the risk involved is reduced or limited. Mutual fund ratings are used to aid active investors judge which funds are perfect for them, based on the degree 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 accord 1 to 5 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.
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 (tax efficiency, expense, and total return, consistent return and preservation) 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
Updated quarterly, Schwab provides a list of no load, no transaction fee funds that have been pre-screened. Using a strict list of criteria before assigning a score including having a minimum of $40 million in assets and having a 3 year performance record. You'll find the fund that make this quarterly list are rated on performance, diversification and risk.
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.
