You can’t read much about mutual funds or ETFs without tripping across references to Morningstar. Morningstar is a company that evaluates mutual funds and ETFs. At the highest level, Morningstar gives a star rating from 1 to 5 to every mutual fund they review (they don’t review all mutual funds).
The following are some key facts about Morningstar’s ratings and analysis of funds:
The star rating, introduced in 1985, provides a simple and easy way for investors to understand the historical performance of the fund, considering the risk of the fund and its fees and expenses.
Morningstar categories are used almost exclusively in the industry to categorize funds. There are dozens of categories of funds. The fund category is determined based on the investments in the fund, regardless of the fund manager’s description of the fund and its objectives. This is a key feature to know before investing in a fund.
Category ratings were introduced by Morningstar in 1996; these ratings are specifically intended to help investors compare two or more similar funds.
The following are some of the key categories you should understand. Depending upon your appetite for risk and your investment goals (retirement, college savings, etc.) these are all fund categories you may wish to own:
A large blend fund is an equity or stock fund that invests in both growth stocks and value stocks (stocks judged to be undervalued compared to other stocks); it is “large” because the stocks it buys are in large companies (the fund itself could be small).
A small growth fund is an equity fund that invests in small growth companies.
A medium value fund is (I bet you can guess) an equity fund that invests in mid-sized companies that are deemed to be undervalued by the manager of the fund.
A long-term government fund is one that invests in government bonds (Federal government, including agencies) with maturities averaging more than 10 years.
Intermediate-term bond funds invest in corporate bonds with maturities of four to 10 years.
Short-term government funds invest in government bonds with maturities of less than four years.
Municipal National Short
This is a fund that invests in state and local government bonds issued by a variety of states that have maturities of less than five years.
While you don’t need to limit yourself strictly to these seven Morningstar Categories, you should be careful when selecting funds outside this roster. As you might imagine, a large growth fund or a long-term bond fund would not be wild choices. Funds that concentrate risk in a “sector” or specific industry, or specific regions of the world or specific states have significantly increased risk compared to funds that invest more broadly. While concentrated risk may increase anticipated return, it also increases the risk of significant damage to your portfolio. Prove your wisdom by investing conservatively and waiting patiently for the rewards.
Devin Thorpe, husband, father, author of Your Mark On The World and a popular guest speaker, is a Forbes Contributor. Building on a twenty-five year career in finance and entrepreneurship that included $500 million in completed transactions, he now champions social good full time, seeking to help others succeed in their efforts to make the world a better place.