"The gap was also impressive as measured by the success ratio because high-cost funds are much more likely to have poor performance and be liquidated or merged away,” Kinnel said. “For the 2005 group, we found that 48% of domestic-equity funds in the cheapest quintile survived and outperformed versus 24% in the priciest quintile. Put another way, funds in the cheapest quintile of domestic equity were twice as likely to succeed as those in the priciest quintile."
Cheaper funds had better success ratios in the other categories and time periods, as well.
Finally, Morningstar looked at its own star-rating system, which measures each fund’s performance in relation to expenses and risk, or how wildly it swings in value. Many investors favor funds with top five-star ratings to those with fewer stars.
Generally, the five-star rated funds beat those with just one star, especially when results were adjusted to reflect the funds that had been shut down or merged with others. In data from 2005, for example, 53% of the five-star funds survived and beat their category average, compared to just 13% of one-star funds.
"Investors should make expense ratios a primary test in fund selection," Kinnel concludes. "They are still the most dependable predictor of performance. Start by focusing on funds in the cheapest or two cheapest quintiles, and you’ll be on the path to success."
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