We’ve all seen the advertisements and “investment pornography” touting Morningstar ratings as being the “be-all end-all” to picking mutual funds. The fact is nothing could be further from the truth, and if anything Morningstar ratings may indicate you should RUN FOR COVER!
Nearly ALL inflows into mutual funds go into 4 and 5 star Morningstar rated funds. This is astonishing considering the number of funds out there and how difficult it is to get a decent Morningstar rating. But should you follow the herd or blaze your own path?
The Morningstar ratings is a grade on PAST PERFORMANCE – NOT future results. The star ratings are an achievement test, NOT an aptitude test. And in fact many funds fall victim to their own success.
Here’s what I mean by that… A mutual fund managers’ achievement may be highly correlated to the size of the fund they managed. In fact, if a manager has success (which I feel is arbitrary anyway, a factor of luck and statistics over skill) with a fund at one size just how in the world can they have the same success when that fund has doubled or tripled in size due to it’s 5 star ratings driven inflows? They simply find it more and more difficult to mange, and most often fail to repeat the success they had in the first place.
Warren Buffett has a few good ideas a year – how do these fund managers pick hundreds of “good ideas” for investment??? They don’t. The reason they pick hundreds of “good ideas” is simply to reduce the risk of underperformance to the benchmark index – usually the S&P 500. Imagine how much MORE difficult it is to put MORE money to work due to substantial investment inflows? It’s hard enough to come up with a few good ideas, then hundreds in the case of most funds, and hundreds more sometimes in the case of a fund which falls victim of it’s own success – 4 and 5 star rated funds.
Morningstar will openly admit – the best place to start for an indication of future investment success of a mutual fund is it’s expense ratio – NOT it’s Morningstar star rating! Find that hard to believe? Just because you ace a test last year doesn’t mean you can ace the same test this year – and in fact if you’ve got a heavier workload (more money to manage in this case) your chances of success may even dwindle further.
Morningstar will tell you to start with the expense ratio – because before any investment returns are tabulated the fund management company must pay themselves, and the more they pay themselves – the less money in your pocket! This is why here at REDROCK WEALTH MANAGEMENT we use only top-tier institutional quality mutual funds and exchange traded funds WITH AMAZINGLY LOW FEES. The fact is, keeping your expenses lower helps us deliver a successful investment experience to you! And at REDROCK – our only goal is your financial and investment success!
