Mutual Fund Rating Essay

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Article Assignment 1
The article “Why Fund Ratings Could Be Misleading” relates mutual fund ratings to the loss aversion experienced by investors. Ratings companies such as Morning Star or Standard and Poor rate mutual funds with a one to five start rating system, with five being the highest. The rating each fund acquires reflects cost and risk adjusted historical performance. The article makes the case that the rating system does not take into account each potential investor’s loss aversion. Loss aversion describes the tendency to prefer to avoid losses to acquiring gains. The article refers to a test designed to evaluate an individual’s loss aversion, called the coin flip test. The coin flip test is where the individual is offered a chance
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The writers of the article feel that the mutual fund rating system should be further tailored to each investors loss aversion which would allow investors to choose the fund that best reflects their financial needs and risk tolerance.
I personally feel that properly educating individuals in personal finance and investing would mitigate the need to expand on the current rating system for mutual funds. Financial loss from investing comes from a permanent decrease in value (bond defaults) or from a temporary decrease in value (market correction) which is realized when sold. Proper financial planning can minimize the chance that an individual’s investment will be valued less than what the individual needs at the time. Diversifying the investment portfolio in many different securities allows the individual to be protected from a single security defaulting, which is the point in investing in mutual funds. Having a sufficient cash buffer and a properly balanced portfolio insulate the investor from temporary market downturns. For example, if an individual is young and starting to save for retirement they would
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Proper budgeting knowledge insures that individuals stay in good financial health and proper investment knowledge allows individuals to build wealth. When a majority of the population is misinformed about their own financial limitations, the result is similar to the 2008 financial crisis. People bought property that they could not afford because they considered real estate to be the best investment. When people don’t know what to expect from their investments they can be cheated by Ponzi schemes or low return high fee mutual funds. The fundamental formula in personal finance is that “money in” should be greater than or equal too “money out”. Most people focus too much on minimizing their “money out” through the use of budgeting, taking advantage of tax benefits and generally living within their means. People often ignore ways to increase their “money in” as a way to balance their budget. Those highly loss adverse individuals and those who have little faith in the financial system are losing out on a huge potential source of income. People too scared or uninformed to invest actually loss money due to inflation, while people who rely on simplified ratings systems on receive lackluster gains. Understanding how to invest is a crucial skill that will allow you to ignore articles such as this one and to avoid being flustered by market news. Being able to cut costs while simultaneously increase income allows people to

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