A 5 Star Rating Equals A Good Fund
Football season is here. I’m so excited. I always love football season. If you’re not a football fan, stick with me here because there’s a really important analogy I want to make here about football and 5-star mutual funds.
The draft was just a few months back but sometimes there’s a disconnect between the high draft choices and how they perform in the NFL.
We can only tell from college how they did in the past. It’s not going to tell us whether they’re going to be a great NFL star.
Yes, it might lead us to think that they should have the qualities that will lead to success, but we all know high draft choices that end up doing nothing in the NFL.
It’s kind of like the five-star ratings on mutual funds. It tells us how things have been done in the past, it doesn’t tell us how things are going to be in the future.
Five-Star Mutual Funds
A five-star rating equals a good mutual fund. You’ve probably heard that before or might even have gone through your portfolio to see what rating your funds are and judge the strength of it based on the stars.
But is that really an accurate factor to look at?
The rating is based on a couple of things.
It is based on the quality of the management and the consistency, it judges a fund over a period of time.
If we are looking back over the past three years, five years, ten years, we’ve had relatively good years, so it’s going to tell you how that fund performed amongst its peers during that time.
But is that the best indicator going forward? Is that what we are really looking at when we’re putting together a portfolio?
If you have all five-star funds, does that mean you have a good portfolio?
The truth is, probably not. A better indicator is looking at what’s going to happen in the future.
Different funds are going to perform better at different times.
The five-star rating doesn’t tell you where the market trend is. It doesn’t tell you which ones are going to be better in any certain market cycles. It just tells you their past experience.
The other thing that’s really important to know is that funds are all competing for your business.
And when do people, advisors, and companies often review investments? When the markets are good, so all these funds are competing on the upside.
They just want to get a little bit higher, a little bit more when the market is up.
But for most of our clients and most of the people we talked to, they’re willing to have a bit less on the upside in exchange for not taking as much of a hit on the downside.
However, most funds are not managing that way. They’re not looking at risk-adjusted returns. They’re not getting their five-star rating because they lost less.
They’re getting it based on the consistency and how they beat the market in the good times.
When you’re looking at what you should have, just because you have five-star funds doesn’t mean you have a solid portfolio.
It’s really important to take a look at how they are managed and the different sectors and strategies that are used in your portfolio.
What Are The Best Mutual Funds?
The truth is, if you have over $100,000 in your portfolio, you have outgrown the need to have mutual funds, even 5-star funds! You’ve really outgrown the efficiency of mutual funds in your portfolio.
They have a great place when we’re starting out and we can’t diversify because we only have $5,000. You can’t diversify among a bunch of stocks with just $5,000.
But as we grow and as our portfolio grows, it doesn’t matter what rating that fund is, you are able to do more and be more efficient by using individual stocks and bonds instead of mutual funds.
What’s most important to you – getting the most on the upside or making sure you don’t take a big loss on the downside?
If the second is true, if you want to not take the biggest loss on the downside, the rating of the fund has no bearing on that.
Do I Need A Money Manager?
It’s all about how things are managed, and the funds are limited in what they can do. You need to look at somebody who is managing not based on the prospectus of this fund and not based on you.
Five-star rating judges the past performance, it doesn’t tell us what’s going to happen in the future.
If you want to know if you have the best portfolio for you, I suggest we do a review.
If what you have is good, it will be obvious, we’ll tell you and you’ll feel more confident going forward.
If there are any issues, if there are any problems, you need to know what they are and why.
So again, five stars ratings measure past performance, it doesn’t tell us about the future. If you have over $100,000, you’ve probably outgrown the efficiency of that fund, no matter how great the rating.
You need to decide what’s most important for you – the max growth or to have your portfolio be agile, able to adjust based on what’s going on as well as managing against the downside.
And most importantly, managed to meet your goals, whether that is retirement income or growth or security.
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