Balanced Fund

What is a Balanced Fund?

A balanced fund is a hybrid mutual fund that combines different securities, including stocks, bonds and money market funds, aimed at achieving a higher return while leveraging portfolio risk.

Balanced mutual funds have holdings that are balanced between equity and debt, with their objective somewhere between growth and income. This leads to the name “balanced fund”.

Balanced mutual funds are geared toward investors who are looking for a mixture of safety, income, and modest capital appreciation.

Understanding Balanced Funds

A balanced fund is a type of hybrid fund, which is an investment fund characterized by its diversification among two or more asset classes. The amounts the fund invests into each asset class usually must remain within a set minimum and maximum value. Another name for a balanced fund is an asset allocation fund.

Balanced fund portfolios do not materially change their asset mix, unlike life-cycle, target-date, and actively-managed asset allocation funds which evolve in response to the investor’s changing risk-return appetite and age or overall investment market conditions.

A balanced fund provides diversification, because an investor’s money isn’t all tied up in a single type of investment. Many investors who choose a balanced fund do so because they want something that’s less vulnerable to the ups and downs of the economy. They also may want something that gives them the best return on their money, even if that means they earn less in a strong economy than they would if they invested in something less secure.

A balanced fund is designed for the long haul rather than for getting rich quick. This makes the income derived from it more modest than many other types of investments, but it also reduces the risk involved.

One selling point of balanced funds is that investors can achieve diversification without having to evaluate several types of stocks and other investments to determine which are the best choices, and they also don’t have to take the time to invest individually in several different types.

The proportion of funds to be invested in equity and debt is predefined in the scheme and can be categorized as:

  • Debt-Oriented funds: At least 65% of the funds are invested in the debt instruments while the remaining portion is invested in the equity segment. These funds are opted by those investors who are likely to take less amount of risk.
  • Equity-Oriented Funds: At least 65% of the funds are invested in the equity segment while the remaining portion is invested in the debt instruments. Here, the investors are willing to take the moderate type of risk.

Thus, the balanced fund is the combination of several stocks and bonds, which is structured to balance the aim of achieving higher returns against the risk of losing money. The investment in stock offer the growth opportunities, while the investment in fixed income securities (bonds) stabilizes the portfolio during the fluctuations in the equity markets. These types of funds are designed for those investors who wants to minimize the risks in such investments.

How Does a Balanced Fund Work?

Balanced funds are one of two general types of income funds (the other type is equity-income funds, which mostly invest in dividend paying stocks). Income funds seek to generate income but give some attention to capital appreciation — that is, capital appreciation is secondary to maintaining current income and capital preservation.

Balanced funds (and income funds in general) are mechanically very similar to bond funds but they include varying amounts of non-debt instruments like preferred stock, common stock, or even real estate. They usually produce higher returns than money market and bond funds but are still relatively conservative, investing in securities from established, creditworthy companies that make consistent dividend payments.

But like bond funds, balanced funds can cover a broad spectrum of holdings. Some will stay heavily invested in low-risk and risk-free securities, while others will test the waters with REITs and junk bonds. It’s important to read the prospectus of any balanced fund to understand the types of instruments the fund manager will invest in.

Types of Balanced Funds

There are three primary types of balanced funds:

  1. Conservative Balanced Funds: These funds will typically hold a balance of stocks, bonds, and cash that is appropriate for conservative investors — those that do not feel comfortable with wide swings in prices. The asset allocation of conservative balanced funds is usually around 35% stocks, 60% bonds, and 5% cash.
  2. Moderate Balanced Funds: These funds normally hold a balance of stocks, bonds, and cash that is appropriate for investors who don’t mind some fluctuation in prices but not as much as a fund with a 100% allocation to stocks. A typical asset allocation for a moderately balanced fund is 65% stocks, 30% bonds, and 5% cash.
  3. Aggressive Balanced Funds: These balanced funds will have the highest allocation to stocks and are appropriate for investors who are comfortable with wide swings in prices. However, a small allocation to bonds can offer diversification that can result in price volatility that is lower than the stock market, as measured by the S&P 500 index. An aggressive balanced fund will typically have an allocation of approximately 85% stocks and 15% bonds.

Advantages of Balanced Funds

Because balanced funds rarely have to change their mix of stocks and bonds, they tend to have lower total expense ratios (ERs). Moreover, because they automatically spread an investor’s money across a variety of types of stocks, they minimize the risk of selecting the wrong stocks or sectors. Finally, balanced funds allow investors to withdraw money periodically without upsetting the asset allocation.

Disadvantages of Balanced Funds

On the downside, the fund controls the asset allocation, not you — and that might not always match with the optimal tax-planning moves. For example, many investors prefer to keep income-producing securities in tax-advantaged accounts and growth stocks in taxable ones, but you can’t separate the two in a balanced fund. You can’t use a bond laddering strategy — buying bonds with staggered maturity dates — to adjust cash flows and repayment of principal according to your financial situation.

The characteristic allocation of a balanced fund — usually 60% equities, 40% debt — may not always suit you, as your investment goals, needs, or preferences change over time. And some professionals fear that balanced funds play it too safe, avoiding international or outside-the-mainstream market and thus hobbling their returns.