Re-balance Cycle Reminder All MyPlanIQ’s newsletters are archived here.
For regular SAA and TAA portfolios, the next re-balance will be on Monday, December 18, 2017. You can also find the re-balance calendar for 2017 on ‘Dashboard‘ page once you log in.
As a reminder to expert users: advanced portfolios are still re-balanced based on their original re-balance schedules and they are not the same as those used in Strategic and Tactical Asset Allocation (SAA and TAA) portfolios of a plan.
Please note that we now list the next re-balance date on every portfolio page.
Mutual Fund Star Ratings: Are They Useful?
Many people are somewhat familiar with mutual fund star ratings that were popularized by Morningstar’s 5 star rating system. For many busy working professionals, they often rely on the star ratings to pick funds in their 401K or other retirement accounts.
Unfortunately, the result of using the ratings system has been very mixed to say the least. Let’s look at the ratings and how they have been used in more details.
How does Morningstar rate mutual funds?
Based on Morningstar:
Morningstar rates mutual funds from one to five stars based on how well they’ve performed (after adjusting for risk and accounting for all sales charges) in comparison to similar funds. Within each Morningstar Category, the top 10% of funds receive five stars, the next 22.5% four stars, the middle 35% three stars, the next 22.5% two stars, and the bottom 10% receive one star. Funds are rated for up to three time periods–three-, five-, and 10 years–and these ratings are combined to produce an overall rating.
Aside from some minor details, the ratings are essentially based on risk adjusted returns or Sharpe ratios in the past.
The most popular Morningstar’s ratings are based on the prevailing three years performance. Morningstar has since introduced a another (less popular and comprehensive) mutual fund gold/silver ratings that they claim to be not only based on the past performance, but also on their human analysts’ subjective view. The methodology is subjective and has short history. It’s thus hard to evaluate.
There are many other fund rating systems such as Lipper, Zack’s, Standard and Poor etc. Most of these ratings are also based on past (risk-adjusted) returns. MyPlanIQ also rates mutual funds using last one year’s Sharpe ratio, among other minor factors.
Research results on the ratings
There have been many debates and studies on the usefulness of these star ratings. We recommend interested readers to read the recent Advisor Perspective article and some of the articles referenced in it.
The following summarizes the findings from these studies:
- Morningstar’s fund ratings (especially for funds rated highest as 5 or 4 star) has a weak predictive power on their subsequent (6 to 1 year) returns. To be precise, it means that 5 star funds on average perform slightly better than 4 star funds and so forth.
- However, the out performance is weak and can disappear soon. In fact, the Wall Street Journal study mentioned in that article contends that the five-star funds can’t maintain their top ratings over time.
- Another study by Advisor Perspectives found that the probability of a randomly selected five-star fund out performs a four-star fund is 50.6%, barely better than flipping a coin.
To some extent, long time readers of our newsletters shouldn’t be surprised by the above results. We have pointed out many times that there is no a reliable way to just pick some managers or investors and then ride on the funds forever.
How are ratings used in practice?
Even though many financial advisors understand the above research result and they seldom rely on the ratings to choose funds, many individual investors don’t have such intimate knowledge on the ratings. A typical misuse of the ratings is as follows:
- When one starts a 401k or other retirement account, she/he looks at the ratings of the funds available in the plan and chooses those with highest ratings.
- Every now and then (without regularity), this investor would look at the ratings, sometimes chooses to replace those that have not done well, sometimes chooses to ignore, hoping the funds will bounce back or thinking like ‘I’m investing in a long term and I don’t want to hop from one fund to another’, or there are other similar reasons behind hanging on those funds.
What we can see from the above typical process is that other than from the initial fund selection, the investor has behaved in a irregular or random way. This behavior certainly defeats the existence of the already weak prediction power of the ratings system.
In fact, the delusion caused by the fund ratings is much more harmful than its usefulness.
The ‘correct’ way to use fund ratings
For all of the fund ratings that are based on past performance, like it or not, using them as a guide to invest means you are essentially committing to a momentum type strategy. However, momentum based investing has to obey a rigid and regular rebalancing (or reexaminination) schedule: it’s actually quite sensitive to this process. In fact, in July 22, 2013: Tactical Asset Allocation: The Good, The Bad And The Ugly newsletter, we stated that:
Unlike buy and hold SAA, TAA is extremely sensitive to the rigorous implementation: if an investor does not follow the strategy for whatever reasons (such as the one above or just simply forget about it), it can be detrimental to follow back: say you miss the current buy and wait on sideline, will you get back into the strategy when markets are even higher? What happens if right after you start to follow it rigorously, it starts to lose (Murphy’s law)? Same can be said for selling.
This is exactly the issue for the Morningstar’s fund ratings: it’s a momentum based metric in disguise but for various reasons, Morningstar and other companies that feature such ratings don’t want to be seen as advocates to frequent buying and selling of mutual funds, let alone even with that, it only barely works.
Our view on these fund ratings is that they are only useful as the very first cut of perusal of funds. One can’t use them as the daily guide for fund selection. There is no such a comfort to just find a high ranked fund and then you are set. Investing is a process, not a one or several time deals.
To do so, you have to commit to a disciplined, intuitive and well researched strategy on a regular basis. In MyPlanIQ, our Strategic Asset Allocation (SAA) and Tactical Asset Allocation(TAA) and the fund selection algorithm are designed precisely for this purpose.
Stocks had gone through some volatile sessions in the Thanksgiving holiday period. Even though general US stock indexes like S&P 500 or Dow Jones 30 have broken records, there is a substantial under current. For example, there has been a considerable divergence among S&P 500 and the high flying semiconductor index SMH:
The likely cause of such a divergence is that investors are rotating out of high priced technology stocks to other sectors such as financials that are believed to have a greater benefit from the current tax reform bill. Many tech stocks such as Nvidia, after their parabolic rise, suffered from huge daily loss in the process. However, whether markets will continue without a correction after such a rotation is anyone’s guess. As always, we don’t want to read into these events too much and instead would simply stay the course and follow the selected strategies.
For more detailed asset trend scores, please refer to 360° Market Overview.
Now that the Trump administration has been in the office for more than half a year, it has stumbled and encountered many difficulties to implement its promised changes in terms of tax cuts, job stimulation and infrastructure spending. On the other hand, stocks continued to ascend, regardless of the progress. Looking ahead, however, we remain convinced that markets will experience more volatilities at some point when reality finally sets in.
In terms of investments, U.S. stock valuation is at a historically high level. It is thus not a good time to take excessive risk. However, we remain optimistic on U.S. economy in the long term and believe much better investment opportunities will arise in the future.
We again would like to stress for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot.
- November 20, 2017: Thankful And Mindful
- November 13, 2017: Is This A Good Time For Retirees Or Would Be Retirees?
- November 6, 2017: Newsletter Collection Update
- October 30, 2017: Rising Interest Rates
- October 23, 2017: A Primer For Portfolios
- October 16, 2017: REITs As An Asset Class
- October 9, 2017: Conservative Portfolios Revisited
- October 2, 2017: The Role of Short Term Bond Funds
- September 25, 2017: Fees In Cash Investments
- September 18, 2017: Conservative Portfolios Review
- September 11, 2017: International Diversification Effect
- September 4, 2017: Invest And Speculate Revisited
- August 28, 2017: Total Return Bond Fund Portfolios: Where Do They Fit?
- August 21, 2017: Portfolio Performance: A Walk In The Past
- August 14, 2017: Fidelity Commission Free ETFs Update
- August 7, 2017: I Didn’t Learn Anything — Mistake vs. Temporary Underperformance
- July 31, 2017: Asset Classes And Fund Choices: A Primer
- July 24, 2017: Total Return Bond Fund Portfolios And Cash
- July 17, 2017: Long Term Stock Holding Periods For Retirement
- July 10, 2017: Half Year Asset Trend Review
- June 26, 2017: How To Beat The Best Balanced Allocation Fund
- June 19, 2017: Newsletter Collection Update
- June 12, 2017: A Mixed Bag Performance of Momentum Investing
- June 5, 2017: How To Start A New Portfolio
- May 29, 2017: Alternative Assets And Their Role In Portfolios
- May 22, 2017: Summer Seasonality And Portfolio Management
- May 15, 2017: Cash: Banking Or Investing?
- May 8, 2017: Holding Period of Long Term Timing Portfolios
- May 1, 2017: Debate on Risk vs. Volatility
- April 24, 2017: The Long Term Stock Market Timing Return Since 1871
- April 17, 2017: Risk vs. Volatility: Long Term Stock Market Returns
- April 10, 2017: Total Return Bond ETFs And Portfolios
- April 3, 2017: Quarter End Asset Trend Review
- March 27, 2017: Practical Consideration For IRAs And 401k Accounts
- March 20, 2017: Fund Fees: That’s (Still) Outrageous
- March 13, 2017: Long Term Stock Valuation Review
- March 6, 2017: Asset Classes for Retirement Investments
- February 27, 2017: Fidelity Total Bond Fund Review
- February 20, 2017: Long Term Stock Timing Based Portfolios And Their Roles
- February 13, 2017: Alternative Investment Portfolios Review
- February 6, 2017: Tax Free Municipal Bond Investments Review
- January 30, 2017: Brokerage Specific Conservative Portfolios
- January 23, 2017: Fixed Income Portfolio Review
- January 16, 2017: Long Term Trend Following Portfolio Review
- January 9, 2017: Tactical Asset Allocation Review
- January 3, 2017: Strategic Asset Allocation Review
- December 12, 2016: Enhanced Index Funds
- December 5, 2016: Review Of Broad Base Core Mutual Funds For Brokerages
- November 28, 2016: Core Index ETFs Review
- November 21, 2016: International Exposure Of U.S. Large Companies
- November 14, 2016: Asset Trends After The Election
- November 7, 2016: Rising Rate And Current Bond Trend
- October 31, 2016: Economy Power And Long Term Stock Returns
- October 24, 2016: Current Commodity Trend And Managed Futures
- October 17, 2016: Investment Mistakes And Good Or Bad Investment Strategies
- October 10, 2016: Momentum Investing Review
- October 3, 2016: Survey & Feedback
- September 26, 2016: Fixed Income Investing: Actively Managed Funds vs. Index Funds
- September 19, 2016: Stock Investing: Actively Managed Funds vs. Index Funds
- September 12, 2016: Newsletter Update
- September 5, 2016: Overvalued Markets And Long Term Timing Strategies
- August 29, 2016: Your 401K Finally Draws Attention
- August 22, 2016: Inflation Protected Securities TIPS For Current Overvalued Markets
- August 15, 2016: Risk On: Emerging Market Stocks And Small Cap Stocks
- August 8, 2016: Portfolio Construction Using Stock ETFs And Bond Mutual Funds
- August 1, 2016: Adding Value To Your Own Investments
- July 25, 2016: Tactical Asset Allocation Funds Review
- July 18, 2016: Strategic Asset Allocation & Lazy Portfolio Review
- July 11, 2016: Asset Trend Review
- June 27, 2016: Secular Cycles For Tactical And Strategic Investment Strategies
- June 20, 2016: A World of Debt
- June 13, 2016: Managed Futures For Portfolio Building
- June 6, 2016: Newsletter Summary
- May 30, 2016: Swensen Portfolio And Permanent Portfolios
- May 23, 2016: AAII Article And Some Web Changes
- May 16, 2016: The PIMCO (Dis)Advantages
- May 9, 2016: Boost Your Dull Summer Investments
- May 2, 2016: Low Cost Index Fund Investing
- April 25, 2016: Tax Free Municipal Bond Funds & Portfolios
- April 18, 2016: Asset Class Trend Review
- April 11, 2016: Construction of Sound And Conservative Portfolios
- March 28, 2016: Total Return Bond ETFs Review
- March 21, 2016: Small And Large Company Stock Performance In Different Economic Expansion Cycles
- March 14, 2016: Are Tactical And Timing Strategies Losing Steam?
- March 7, 2016: Defined Maturity Bond Fund Analysis
- February 29, 2016: Smart Strategic Asset Allocation Rebalance When Market Trend Changes
- February 22, 2016: Be Cash Smart
- February 15, 2016: Bond ETF Portfolios
- February 8, 2016: Newsletter Collection Update
- February 1, 2016: Total Return Bond Fund Portfolios In A Volatile Period
- January 25, 2016: Alternative Portfolios Review
- January 18, 2016: Strategic Asset Allocation: A Cautious Outlook
- January 11, 2016: Review Of Trend Following Tactical Asset Allocation
- January 4, 2016: What Worked And Didn’t In 2015
- December 21, 2015: Distressed Assets
- December 14, 2015: High Yield Bonds And Their Correlation With Stocks
- December 7, 2015: Diversification And Global Allocation
- November 30, 2015: Investors and Speculators Combined
- November 23, 2015: Active Stock Fund Performance Consistency
- November 16, 2015: Permanent, Risk Parity And Alternative Portfolios Review
- November 9, 2015: Broad Base Core Mutual Fund Review
- November 2, 2015: Broad Base Index Core ETFs Review
- October 26, 2015: Total Return Bond Fund Review
- October 19, 2015: Advanced Portfolio Review
- October 12, 2015: What About Commodities?
- October 5, 2015: Core Satellite Portfolios In A 401k Account
- September 28, 2015: Risk Managed Strategic Asset Allocation Portfolios Revisited
- September 21, 2015: Quest For The Best Investment Strategy
- September 14, 2015: Core Satellite Portfolios In Market Turmoil
- September 7, 2015: Market Rout Creates An Opportunity to Reposition Your Portfolios
- August 31, 2015: Review of Asset Allocation Funds and Portfolios
- August 24, 2015: Market Rout And Your Portfolios
- August 17, 2015: ETF or Mutual Fund Based Portfolios
- August 10, 2015: Updated Newsletter Collection
- August 3, 2015: Slippery Asset Trends
- July 27, 2015: Performance Dispersion Among Momentum Based Portfolios
- July 20, 2015: Global Balanced Portfolio Benchmarks
- July 13, 2015: Pain in Tactical Portfolios