Be Careful With Mutual Funds' Use of Morningstar Star Rating System

Morningstar's star rating system is well known, and greatly used in advertising and marketing materials. But be careful.

First, the star ratings simply are for comparison purposes. So do not think that a 5-star mutual fund has had outstanding actual performance over the relevant time period (Morningstar uses three years). It might not have. The star system simply compares a particular fund's performance, however good or bad, to the overall performance of the fund category.

Second, the categories, for purposes of the star rating system, are very broad. There only are four categories: funds investing in U.S. stocks, international stocks, taxable bonds and tax-exempt municipal bonds. Thus, a fund's high star rating may reflect that the category (for example, U.S. stocks) has been in favor, and a large number of similar funds may receive high ratings.

Third, all ratings and rankings are backward looking. They are not a prediction of future performance results, Morningstar warns.

Source: Wall Street Journal, March 22, 2002