Morningstar is a mutual fund rating agency. It ranks a fund’s performance by using one to five stars. A one-star mutual fund is in the bottom 10% of its investment class; a five-star mutual fund is at the 90th percentile of its investment class. Interpret the meaning of a five-star mutual fund.

Verified step by step guidance

1. Understand that the star rating system is based on percentiles, which indicate the relative position of a fund's performance within its investment class.
2. Recognize that a five-star mutual fund is at the 90th percentile, meaning it performs better than 90% of the funds in the same investment class.
3. Interpret this as the fund being among the top 10% of all funds in its category, indicating strong historical performance compared to its peers.
4. Note that this ranking is relative, so the five-star rating reflects the fund's performance compared to others, not an absolute measure of return.
5. Conclude that investing in a five-star mutual fund suggests choosing a fund with a track record of outperforming most of its competitors.

Key Concepts

Percentiles

Percentiles indicate the relative standing of a value within a data set. For example, a fund at the 90th percentile performs better than 90% of funds in its class, showing it is among the top performers.

Mutual Fund Ratings

Mutual fund ratings categorize funds based on performance metrics, often using stars to simplify comparison. A five-star rating signifies superior performance relative to peers.

Investment Class

An investment class groups funds with similar investment objectives or asset types. Comparing funds within the same class ensures fair performance evaluation.