Five Star FallacySubmitted by Grunden Financial Advisory, Inc on June 11th, 2010
A recent article on CBS Money Watch  illustrates how some investors invest in Moringstar’s Five Star Ranked Funds (the highest Morningstar rating available) only to realize they’re late to the party. As it turns out, new investors into a five-star fund usually end up buying a fund near its high watermark.
While the proper disclosure Morningstar utilizes states “past performance is not a guarantee of future results”, the five-star fallacy nonetheless lures investors in. Many investors realize nothing is guaranteed, but the prestigious classification of a “five-star fund” still creates value in their minds. The referenced article says, “over the following three and five years, the funds’ average performance will fall to the middle of the pack.” Investors can rarely win when they chase performance.
Another approach championed by sage advisors is to understand your risk tolerance at the beginning and develop an investment plan based on asset class investing using low cost funds. The article concludes by saying, “of the so-called predictors of future performance, low cost is the only one that consistently works.”
 ‘Morningstar Star Rankings Fail Mutual Fund Investors’, Jane Bryant Quinn, CBSMoneyWatch.com, May 6, 2010.