Course 206: Gauging Risk and Return Together, Part 2
Caveats
In this course
1 Introduction
2 What Is the Star Rating?
3 Caveats

Like all backward-looking measures, the star rating has limitations. It is critical to remember that the rating is not a forward-looking, forecasting tool. The rating won't predict short-term winners. The star rating is best used as an initial screen to identify funds worthy of further research—those that have performed well on a risk-adjusted basis relative to their peers.

The star rating is a strictly quantitative measure—a high rating doesn't imply the approval or endorsement of a fund by a Morningstar analyst. Additionally, if a management change occurs, the ratings stay with the fund, not with the portfolio manager. Therefore, a fund's rating might be based almost entirely on the success of a manager who is no longer with the fund.

Also, because funds are rated within their respective categories, it's important to note that not all 5-star funds are equal or even interchangeable. A 5-star sector fund, for example, might have the best risk-adjusted return within its specific category, but it's probably far riskier than a highly rated diversified fund.

Rather than buying funds based on their ratings, investors should first decide on an overall portfolio strategy and then seek the best funds for each portion of their portfolios. Use the star rating as a first screen.

Next: The Quiz >>


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