Everything You Need to Know About Balanced Funds
Experts often warn investors against putting all their eggs in one basket. This is why diversification of portfolios has been touted as the best strategy for long term investments. Mutual funds are a great way to diversify your portfolio. They are generally classified according to their asset class. These funds are called equity funds if they hold stocks, and bond funds or fixed income funds if they comprise bonds.
Equity funds are the ideal route to follow if you are looking for a progressive increase in your wealth. But they come with associated risks and are easily subject to market volatility. On the other hand, bonds provide a fixed income with less interference from the market, thereby making it a safe asset class for investors. To balance these two extreme ends of the spectrum, there is a special type of mutual fund known as balanced funds.
What are balanced funds?
Balanced funds, also known as hybrid funds, asset allocation funds, or blended funds, are a mix of equities and bonds usually in a 60:40 or 40:60 ratio, depending solely on the orientation of the fund. They may sometimes also include other money market securities. The idea behind balanced funds is asset diversification. You can do so by prudently investing in lower-risk assets simultaneously with high return stocks.
Balanced funds offer the investor varied options under one roof, instead of buying different mutual funds. The concept of balanced funds finds its roots in behavioral economics, with their implementation depending more on the psychology of the investors rather than physical returns. Most investors prefer slightly lower returns devoid of risks over higher returns and market fluctuations. Balanced funds avoid panic among investors as their money holds its value even during a rough patch.
What are the different types of balanced funds?
They are broadly classified into two categories based on the majority of the asset class they hold.
- An equity-oriented fund is one where approximately 65% of its assets are invested in equities, while the rest fall in debt’s basket.
- A debt-oriented fund on the other hand, comprises at least 65% of its asset in bonds.
There is much leeway in asset allocation, and it is important to read the fund prospectus carefully before opting between the two. But allocation can be changed by an asset manager even in between as per the need of the market.
Here’s an example of balanced funds: The American Balanced Fund holds around 56% in stocks, 33% in bonds and the rest in cash or cash equivalents.
What are the advantages of balanced funds?
Balanced funds come with a ton of advantages. Here are some of their benefits:
- Offer portfolio diversification: As discussed earlier, diversifying your investment portfolio reduces the risk to a great extent. Instead of running after different products, balanced funds help you achieve diversification in a single structure. In many funds, the asset manager also reallocates assets according to market fluctuations. This is typically helpful for people who want to invest in the stock market but have low tolerability.
- Apt for newcomers: Since most of the work is handled by a professional fund manager, balanced funds can be seen as an “invest and forget” method. You do not need to worry about purchasing and selling stocks as the fund manager keeps a keen eye on the market and takes the best suitable course for your investment. Balanced funds are conducive to first-time investors.
- Deliver consistent returns: Although equity stocks vary, bonds usually translate into a stable and consistent return over a long period of time. They provide stability in your investment with an option to withdraw systematically. The returns may not be very high but they guarantee a soft landing.
- Reduce investor anxiety: Balanced funds are a good alternative for people who are susceptible to anxiety and panic over returns. It keeps you insulated from market euphoria while your fund manager manages your investment.
What are the disadvantages of balanced funds?
Despite many advantages, these funds also pose some minor threats like:
- Hidden risk: Although they are associated with less risk than investing in equity mutual funds, nonetheless balanced funds are not completely risk-free due to their equity component, especially when the majority of assets are allocated to stocks.
- Less control: You have very limited control over the choice of funds or the amount to be allotted to a particular stock. The administration lies completely with the fund manager.
- High fees: The fees involved may sometimes be more than investing in different mutual funds. There is a whole team of research analysts and professionals working at the backend who closely monitor both debt and equity markets. The fees charged by them can make balanced funds a less viable option for many investors.
- Unprofitable returns: For big and experienced investors the returns offered by a balanced fund may not sound very attractive, as investing in them may lead to missing out on the full potential of the bullish equity market.
- Inadequate for long-term investment: Balanced funds are best utilized for an intermediate financial goal, like buying a car, or funding higher education. It is best used for an investment period ranging between 4 to 8 years and does not perform well for long term investments.
Are balanced funds for everyone?
Experts suggest that balanced funds are for people who are relatively new to the market and have little knowledge about investing money. The focus of these funds is more towards keeping your investment safe, rather than increasing your wealth. It is best suited for medium-term investors, or a person nearing the retirement age within 5-7 years.
To sum it up
The biggest benefit of balanced funds is that it diversifies your portfolio assets, thereby reducing the risk. For a 60:40 ratio in favor of equity, the average return for a balanced fund can be as high as 7.8%. If you decide to opt for a balanced fund, try not to panic or withdraw funds every time there is a market downturn. Also try cutting the fees you pay to your fund manager to a maximum of 1.5% of the fund value.
To gain from a balanced fund, it is important to find an expert who understands your profile. Reach out to financial advisors to know how you can make profitable investments.