Morningstar is a highly regarded financial services firm whose mission revolves around providing investors with the research and tools they need to make informed decisions in their portfolios.
Those tools, used by individual investors as well as institutional investors and financial advisors, include Morningstar fund ratings, which can help investors gauge how well various mutual funds and exchange-traded funds (ETFs) have performed over time.
But if you’re a new investor, you may have questions like:
• What is Morningstar rating and how is it determined?
• How much do Morningstar ratings matter for selecting mutual funds or ETFs?
• What does Morningstar rating mean when comparing one fund to another?
Taking a deeper look at Morningstar’s fund ratings system and how it works can help investors to decide how reliable it is and how to use the ratings when making investment decisions.
Recommended: Building an Investment Portfolio
What Is the Morningstar Rating?
This is a common question among beginner investors. In simple terms, the Morningstar ratings system is a tool investors can use to compare mutual funds and ETFs. And if you’re wondering whether Morningstar ratings are legitimate, the answer is yes. Even FINRA, the Financial Industry Regulatory Authority, using Morningstar ratings in its Market Data Center .
Morningstar reviews of mutual funds and ETFs reflect different metrics, depending on which ratings system is being applied. The main Morningstar ratings investors may turn to learn more about a particular investment are the Star Ratings and Analyst Ratings. (Morningstar also has a separate ratings system for individual stocks.)
The most recent Star Ratings are free to access, but the Analyst Ratings require a subscription that ranges from $29.95 per month to $449 for a three-year term. In addition to the analyst ratings and reports, a subscription will give you access to a dashboard to track your investments. You may also be able to access similar tools for free from other providers.
You can use these ratings to select from the funds available in your 401(k), or to decide which funds to add to an IRA or a taxable brokerage account.
Recommended: How to Open Your First IRA
The “Star Rating” Explained
The Morningstar Star Rating system, more simply referred to as star rating, is a quantitative ranking of mutual funds and ETFs. Introduced in 1985, the star rating looks backward at a fund’s past performance, then assigns a rating from one to five stars based on that performance. The firm recalculates and updates its star ratings at the end of each month.
Morningstar reviews ETFs and mutual funds with a record of more than three years, so newer funds do not receive a star rating until they’re reached this milestone. The rating methodology utilizes an enhanced Morningstar risk-adjusted return measure. Specifically, the star ratings system looks at each fund’s three-, five- and 10-year risk-adjusted returns.
Star ratings can serve as a report card of sorts for comparing different funds, based on how they’ve performed historically. The Morningstar ratings are not forward-looking, as past performance is not a foolproof indicator of future behavior. But investors can use the ratings system as a starting off point for conducting fund research when deciding where to invest.
If you’re looking for a tool to help you compare mutual funds or exchange-traded funds at a glance based on past performance, the star rating system can help.
Recommended: ETFs vs. Mutual Funds: What is the Difference?
The “Analyst Rating” Explained
The Morningstar Analyst Rating takes a different approach to ranking funds and ETFs. Instead of looking backward, the qualitative analyst rating looks forward to assess a fund’s ability to outperform similar funds or a market benchmark. Rather than using stars, funds receive a rating of Gold, Silver, Bronze, Neutral or Negative, based on the analyst’s outlook for performance.
The firm does not update analyst ratings as frequently as star ratings. Morningstar reviews for analyst ratings are reevaluated at least every 14 months. The firm typically assigns analyst ratings to funds with the most interest from investors or the most assets.
When ranking funds, analysts look at three specific metrics:
Performance is also taken into account within the People and Process pillars. In order to earn a Gold, Silver or Bronze rating, an analyst must determine that an active fund can beat its underlying benchmark when adjusted for risk.
Generally speaking, these Morningstar reviews go into more detail, in terms of the analysis, ranking, and comparison of funds. If you’re an active trader or a buy-and-hold investor you might use the Morningstar analyst ratings to get a feel for what a particular mutual fund or ETF might do next.
Example of a Morningstar Rating
Morningstar star ratings are free to access for investors on Morningstar.com. To find a star rating for a particular fund or ETF you’d simply search for it using its name or ticker symbol. You can also view Morningstar ratings and picks for funds by category, such as small-cap funds or U.S. index funds.
Here’s an example of a Morningstar rating for the Calvert International Responsible Idx I fund (CDHIX) . This fund, which is in the foreign large-blend category and is an index fund, has a four-star rating from Morningstar. You can see at a glance that the fund has an expense ratio of 0.29%, a minimum investment of $100,000 and just over $602 million in assets.
If you want to view Morningstar analyst ratings for a fund or ETF, you’ll need to sign up for a Premium account. You can, however, try it free for 14 days first to decide if it’s worth paying for.
Are Morningstar Ratings Accurate?
Morningstar fund ratings are designed to be a guide to use as you invest, rather than the absolute word on how well a fund is likely to perform. So, how well do Morningstar ratings perform over time and are they an accurate guide for investing?
According to Morningstar’s own analysis of its ratings system, the star ratings can be a useful jumping-off point for investors. That analysis resulted in three key findings:
• Funds with higher star ratings tend to have lower expense ratios and be cheaper for investors to own
• Higher rated funds tend to be less volatile and experience less dramatic downward swings when the market is in flux
• Funds that received higher star ratings tended to produce higher returns for investors compared to funds with lower ratings
The analysis didn’t look specifically at how star ratings and fund performance aligned through different bull and bear markets. But the ultimate conclusion Morningstar drew is that the Star Ratings tend to steer investors toward cheaper funds that are easier to own and stand a better chance of outperforming the market.
Use Expense Ratios
According to Morningstar, fees are one of the best predictors of future performance, at least for Star Ratings. For funds and ETFs, that means it’s important to consider the expense ratio, which represents the cost of owning a fund annually, calculated as a percentage of fund assets.
Actively managed funds typically carry higher expense ratios, as they require a fund manager to play an important role in selecting fund assets. Passively managed funds and ETFs, on the other hand, often have lower expense ratios.
So which one is better? The answer is that it all comes down to performance and returns over time. A fund with a higher expense ratio is not guaranteed to produce a level of returns that justify higher fees. Likewise, a fund that has a lower expense ratio doesn’t necessarily mean that it’s a poor investment just because it’s cheaper to own. Morningstar’s research found that the average one-star fund cost significantly more than the average five-star fund.
As you do your own research in comparing funds and ETFs, consider both performance and cost. This can help you find the right balance when weighing returns against fees.
How Should Investors Use Morningstar Ratings?
How much do Morningstar ratings matter in the grand scheme of things? The answer is, it depends on what you need from investment research tools.
Morningstar reviews of mutual funds and ETFs can be helpful for comparing investments, especially if you’re just getting started with the markets. Morningstar is a respected and trusted institution and both the Star and Analyst Ratings are calculated using a systematic approach. The reviews aren’t just thrown together or based on a best guess.
They’re designed to be a guide and not a substitute for professional financial advice. So, for instance, you may use them to compare two index funds that track the same or a similar benchmark. Or you may use them to compare two ETFs that are representative of the same market sector.
Risks of Morningstar Ratings
Morningstar Ratings are not an absolute predictor of how a mutual fund or ETF will perform in the next five minutes, five days, or five years. After all, there’s no way to perfectly predict how any investment will perform as the market changes day to day or even minute-to-minute.
One risk to avoid with Morningstar ratings is relying on them solely as your only research tool and not doing your own independent research. Again, that means checking expense ratios as well as looking at the underlying assets of a particular fund and its investment strategy (i.e. active vs. passive) to determine how well it aligns with your goals and risk tolerance.
Looking only at Morningstar reviews without doing your own due diligence could cause you to invest in funds that aren’t the best fit for your portfolio. Or you may overestimate how well a fund will perform, only to be disappointed later. For those reasons, it’s important to look under the hood, so to speak, to ensure that you fully understand what you’re investing in before buying in.
Having research tools can help you make educated decisions about where and how to invest. Morningstar Ratings are one tool you can use. When you’re ready to invest and apply the knowledge you’ve acquired, the next step is opening an online brokerage account.
With the SoFi Invest brokerage platform, you can trade individual stocks, exchange-traded funds, cryptocurrency and even get access to Initial Public Offerings (IPOs). It’s simple and convenient to start trading with SoFi or if you prefer, you can put your portfolio on autopilot with automated investing.
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC Registered Investment Advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.sofi.com/legal. Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or pre-qualification for any loan product offered by SoFi Lending Corp and/or its affiliates.
Exchange Traded Funds (ETFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or by email customer service at [email protected] Please read the prospectus carefully prior to investing. Shares of ETFs must be bought and sold at market price, which can vary significantly from the Fund’s net asset value (NAV). Investment returns are subject to market volatility and shares may be worth more or less their original value when redeemed. The diversification of an ETF will not protect against loss. An ETF may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.
Third Party Brand Mentions: No brands or products mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third party trademarks referenced herein are property of their respective owners.