Everything You Need to Know About Balanced Funds

Convenience, thy name is mutual funds!

Mutual funds have really simplified how the world invests. Gone are the days when building a portfolio meant spending hours handpicking individual stocks and bonds. You had to keep one eye on market news and another on price movements, while still finding time to decide when to buy or sell.

Now, you can simply invest in a mutual fund scheme and let a professional fund manager handle all of this and more for you. They track the markets, make buying and selling decisions, and manage the fund’s portfolio, so you don’t have to worry about the details.

Different types of mutual funds cater to different goals. Equity funds focus mostly on stocks, aiming for long-term growth. Bond funds are biased toward fixed-income securities and offer stability. And then, there is the middle ground with the balanced fund. This is where you get a mix of both worlds. Balanced funds combine stocks for growth and bonds for stability.

Let’s discuss the third category a bit more.

What is a balanced fund?

A balanced fund is a type of mutual fund that invests in two primary asset classes – stocks and bonds. The whole idea is right there in the name. These funds offer a balance. The fund maintains a specific mix between the two asset classes, so you are not fully exposed to market swings, but you are also not stuck with slow, predictable returns. They are also known as hybrid funds as they follow a hybrid approach to investing.

Balanced mutual funds are different from equity mutual funds, which are entirely invested in stocks. They are also not the same as bond funds, which focus solely on bonds. Moreover, balanced funds are often confused with target date funds or life-cycle funds. But they are not the same.

Target-date and life-cycle funds automatically adjust their mix over time as you approach a specific date, such as retirement. They gradually shift from higher-risk stocks to safer bonds.

Balanced funds, on the other hand, maintain a relatively steady mix. For instance, if the fund is designed to have 60% stocks and 40% bonds, it will generally maintain this ratio year after year. There may be slight changes at the fund manager’s discretion, but the overall mix will be more or less the same throughout.

Balanced funds can be managed in two ways. Some are index-based. These are passively managed and aim to match the performance of a specific index. Others are actively managed by professional fund managers. These professionals are responsible for determining which stocks and bonds to purchase and sell.

Both types of balanced funds have their pros and cons, and the one that is right for you will depend on your goals, time horizon, and comfort with risk. Balanced funds can also be an Exchange-Traded Fund (ETF) or a Unit Investment Trust (UIT).

Balanced fund asset allocation is uniquely designed to offer you dual advantages. The equity portion of a balanced fund gives you the growth potential, as stocks tend to perform better over the long term. The bond portion provides stability and the potential for regular income, which can help cushion your portfolio during market downturns. Most balanced funds maintain a stock exposure of between 35% and 65%, with the remainder allocated to bonds.

Why should you invest in balanced funds?

There are plenty of reasons to consider putting your money into a balanced fund, and most of them come down to one thing. These funds make your investing life easier. Let’s walk through the other big ones:

1. Double exposure — two for the price of one

In investing, you do not always get everything you want wrapped up neatly in one package delivered to your doorstep. You have to step out, walk to multiple storefronts, and handpick products. Usually, if you want stocks, you have to buy stocks. If you want bonds, you buy bonds. Then, you have to determine how much of each you should own.

But with balanced funds, you can get the best of both worlds in one single investment. These funds put part of your money into equities for growth and the rest into debt or fixed-income instruments for stability.

One purchase. Two major asset classes. No looking around. And, no complex decision-making.

2. Diversification without the headache

If you have ever spoken with a seasoned investor or financial advisor, you have probably heard about diversification and its benefits repeated often. It is one of the golden rules of investing because it spreads your money across different asset classes, reducing the risk of a single bad performer sinking your entire portfolio.

Balanced fund asset allocation makes this ridiculously easy.

You don’t have to buy multiple products to achieve diversification. You can fulfill almost all of your diversification needs with one fund.

3. Beginner friendly

If you are new to investing, you may not be familiar with building an ideal portfolio. How much should you put in stocks? Which bonds should you choose?

Balanced funds can solve your dilemma by allowing experienced fund managers to make those decisions for you.

The result?

You receive a portfolio designed to grow and protect your money. However, you do not need to put it all together yourself.

4. Lower volatility, reduced risk

The stock market can be very dramatic when it wants to. It could swing up higher than the International Space Station and crash down harder than a sinking ship at the Bermuda Triangle. If you are not comfortable with such swings but still want the growth potential of equities, balanced funds offer a great middle ground. The bond portion of the portfolio serves as a cushion, helping to smooth out volatility.

Note: Balance funds do not eliminate risk entirely. That is impossible. But they do help you manage it in a smart way.

5. Potentially low expense ratios

Because you are getting both equity and debt exposure in one place, you may end up paying less than if you tried to build the same mix by buying multiple separate funds. And if you choose a passively managed balanced fund, you can keep costs even lower.

6. Huge time savings

Managing a diversified portfolio on your own takes time, research, and above all, constant monitoring. You need to stay updated on market trends, decide when to buy or sell, and ensure your asset allocation remains in line with your needs.

A balanced fund takes that entire to-do list off your plate. The professionals running the fund handle all the nitty-gritty for you. Meanwhile, you can just take your Pina Coladas down to the beach and enjoy!

7. No need for rebalancing

Some investments grow faster than others. Say you invest 60% in stocks and 40% in debt. Your debt investment grows over the next five years and now forms 50% of your portfolio. Now, you need to rebalance your portfolio by selling some debt securities and using the proceeds to buy more equity. This can be a lengthy task that requires researching, buying, selling, tracking, and more.

With a balanced fund, that is already done for you. The balanced fund asset allocation between stocks and bonds stays consistent without you lifting a finger.

But are balanced funds perfect, after all?

Nothing in investing is perfect. Every product has its drawbacks, and balanced funds are no exception. While they can be incredibly convenient and beginner-friendly, they are not the best choice for everyone. Before you jump in, here are a few things you should think about:

a. Higher expense ratios if these funds are actively managed

If you choose an actively managed balanced fund, you might notice the expense ratio is higher compared to some other investment options. When you pay for professional fund managers to pick your stocks, choose your bonds, and constantly adjust the portfolio, you end up paying more in the form of expense ratios. These costs can easily eat into your returns. Therefore, be mindful when selecting funds and consider alternatives, such as index-based balanced funds.

b. Potentially tricky tax situations

This one catches some investors off guard. Balanced funds can complicate tax planning. Normally, you might put your high-growth investments, like stocks, in a taxable account so you can take advantage of long-term capital gains rates, which are lower than short-term capital gains tax.

Likewise, it may be advisable to keep your income-producing investments, such as bonds, within a tax-advantaged account. This helps you save on annual taxes.

But when you invest in a balanced fund, the stocks and bonds are wrapped together in one single fund. You cannot differentiate them for tax purposes, which muddies up tax planning.

c. Fixed asset allocations

Balanced funds stick to a set allocation between stocks and bonds, for example, 60% equity and 40% fixed income. That is part of their appeal, but it can also be a limitation. If your personal risk tolerance changes or you want to shift more heavily toward one asset class, you can’t just tweak the mix like you could with a custom-built portfolio. You are pretty much stuck to the allocation the fund manager has decided on, for better or worse.

d. Lower return potential compared to pure equity funds

By design, balanced funds blend growth with stability by investing in both equity and debt. This mix can help you avoid stock volatility, but you will also likely miss out on the highest long-term returns that equities alone can deliver.

If your primary goal is to maximize growth and you can tolerate the risk, a pure equity strategy may outperform a balanced fund. This is something you must discuss with your financial advisor

What goals should you use balanced funds for?

Balanced funds can be suitable for the following goals:

• Retirement: Balanced funds can be especially beneficial for those approaching retirement, offering a mix of growth and stability. For example, if you are 55 and plan to retire at 60, investing your money in a balanced fund could help you achieve moderate growth while reducing risk. This can be a suitable shift from equity at this stage of your life without having to move entirely to debt. You can speak with a financial advisor to find the best-balanced funds for retirement that suit your goals.
• Post-retirement: You do not have to completely eliminate equity funds from your portfolio just because you are retired. In fact, balanced funds can be suitable for post-retirement needs if you want to maintain some equity exposure for inflation protection while still keeping a cushion of debt instruments.
• Intermediate goals: Goals, such as buying a car, funding a child’s education expenses, or planning a major vacation in the next three to five years, can be fulfilled with balanced funds. With moderate returns and risk, balanced funds can be suitable for all medium-term goals.
• Beginner-friendly goals: If you are just testing the waters with equity investing but want the safety net of debt allocation, consider investing in balanced funds and enjoying the balanced investing approach they offer.

Verdict?

All in one package of simplified investing, moderate returns, and balanced risk, but with limited flexibility, potentially higher fees, and the possibility of throwing a wrench into your tax strategy.

Balanced funds really are like an all-in-one investing package. They take a lot of the decision-making off your plate by automatically splitting your money between stocks and bonds. They give you the growth potential of equities with the stability of fixed income. They can deliver moderate, steady returns that work for a variety of goals, from retirement savings to mid-term plans.

But if you choose an actively managed balanced fund, it can come with higher expense ratios, and its structure can make tax planning a little more complicated. They also may not be the best choice if your primary aim is to maximize long-term returns, since pure equity investments often outperform over decades.

Still, if you want a simple, diversified, and relatively low-maintenance investment, balanced funds can be a great addition to your portfolio. Just make sure you understand the pros and cons for your situation.

And, consider discussing your options with a financial advisor. Tools like the Wiser Advisor’s free advisor match tool can match you with seasoned professionals who can help you explore different balanced funds.