Tuesday, October 9, 2007

How Can I Find The Best Performing Mutual Funds?

As the old saying goes, "You judge a horse by its track record," and that is probably true in most instances. However, it is not necessarily true when assessing the performance of mutual funds. Using past performance to determine a fund's future performance is much like looking behind you to see ahead. It is not exactly an effective measure.

There are several companies that assess mutual funds and assign them ratings based on specific criteria. Quite often, those criteria consist of viewing the fund's past performance over a five year or ten year period. However, this method has not proven to be effective in determining how a fund will perform in the future. So, short of polishing up the ole crystal ball and calling in to the psychic hotline, what is the conscientious investor to do?

Morningstar is one of the first companies that springs up when folks start talking about mutual fund ratings. As the most popular fund rating company, Morningstar uses a star system to rate funds, with five stars being top performers and one star being poor performers. However, the crux of Morningstar's ratings system is on past performance and that system may prove to be somewhat flawed.

Another source of fund rating is Lipper Leader Fund Ratings. Lipper uses five criteria in ranking mutual funds: total return, consistent return, preservation, tax efficiency and expense. They do factor in past performance, but the system seems to be more focused on analytical formulas than on past performance. Interestingly, investors must register with Lipper in order to access the fund rankings while Reuters uses Lipper rankings, yet allows immediate access to the information.

Business periodicals such as Business Week often publish their rankings of mutual funds, often on an annual basis. Business Week, for example, does publish the "Mutual Fund Scorecard" annually in their magazine, but it can be accessed online at their website. On the website, the Scorecard is updated monthly.

There are many magazines for business and investing that publish stock picks and mutual fund ratings. Some publish the information on an annual basis while others do so monthly. A discerning investor will be able to decipher the information and make an educated decision based upon the information from these publications as well as other sources.

Schwab's One Source Select List uses "rigorous criteria" to establish a list that is published quarterly and outlines their version of top ranking mutual funds. While the Schwab name is well known and trusted in the business and investing community, the disclaimer that precedes the ratings seems to be longer than the explanation for how the experts established the ratings. However, they do have an easy to understand table that lays out all the information on each fund. They even draw you pictures to show your risk level on each fund.

The bottom line here is that if you want to use ratings as a method of selecting the mutual funds in which you want to invest, it would be wise to assess several different sources with different ranking methods and see which mutual funds consistently rise to the top. Using just one rating source may not be an entirely effective method if you wish to invest wisely.

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