Related topics: mutual funds, investing strategy, ETF, bonds, stocks
A new study reinforces time-tested advice for investors shopping for mutual funds: Look first for funds with low fees, then go from there.
Fund expenses are a slightly more important factor in predicting how well a fund will perform than the one- to five-star system that Morningstar uses to rate funds, the company said in a study it published in August.
Comparisons of fund fees and star ratings "have demonstrated they're both useful tools for getting the odds in your favor, and they're very good starting points for investors," said John Rekenthaler, who helped produce the study and is the vice president of research at Morningstar, which is based in Chicago.
The star ratings, which date to Morningstar's founding in 1984, are widely used to sort the good funds from the bad, and many fund companies run ads touting their funds' five-star ratings. Other research firms provide less commonly used ratings that follow different methodologies.
Morningstar's star system measures a fund's past performance while weighing how much risk a fund took to achieve its returns. For example, a fund that produced far-better-than-average results over 10 years won't necessarily secure a top rating if its performance was unusually volatile during that period.
The star ratings "are a summary of what has occurred in the past and an introduction to a fund," Rekenthaler said.
Funds charging lower fees than most of their peers are far more likely to get higher star ratings from Morningstar than pricier ones, Rekenthaler noted.
In 58% of the instances that Morningstar studied, expenses were a better predictor of success than a fund's star rating. Expenses were a bigger factor in 23 of 40 cases comparing data starting in 2005 and ending in March 2010.
The easiest way to compare fees is to consider a fund's expense ratio -- the continuing charges that investors pay, expressed as a percentage of assets -- against the expenses that similar funds charge.
For example, expenses at an emerging-markets stock fund are likely to be higher than those of a Standard & Poor's 500 Index ($INX) fund.
The study concluded that investors should make expense ratios a primary test in fund selection, because they are still the most dependable predictor of performance.
This article was reported by Mark Jewell for The Associated Press.
