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If what you’ve read so far, about all the many different types of mutual funds, makes you want to throw your hands up in despair, I have a solution: balanced mutual funds.
By: Robert F. Abbott, freelance writer and author
Balanced funds offer one-stop shopping of a sort. In one fund, you get some stocks, some bonds, and perhaps a little bit of money market funds. You might also find a balanced fund that provides international exposure or some other type of security.
In some cases, the trade-off for this convenience is a lower rate of return. However, we need to qualify that statement. You see, by combining stocks with bonds in one fund, you should not soar as high, nor fall as far.
Taking a Middle Course
When the stock market goes up by leaps and bounds, your balanced fund will grow, but not nearly as fast as a fund dominated by stocks (also called equities). That’s because bonds generally decline as stocks go up, so the bond portion of your portfolio will slow the fund’s growth.
On the other hand, when the stock market goes down, the value of bonds will likely increase. That means you’ll suffer a smaller loss, or perhaps no loss at all, when the Dow Jones and the rest of the stock market indicators tumble.
Every balanced fund will experience the investing world differently. That’s because of the many different ways a balanced fund can be structured.
Variations on a Theme
While every balanced fund will include some stocks and some bonds, they will have different allocations. A more aggressive fund will have more stocks than bonds: for example 60% stocks, 30% bonds, and 10% in cash or a money market mutual fund. A more conservative fund might reverse the ratio of stocks and bonds, while staying at about 10% in cash.
In addition, within the stock portion of a balanced fund, different fund companies and fund managers may have mandates that make funds more aggressive or conservative. If a manager opts to include small (riskier) companies in the stock allocation, then that fund will experience more volatility than a fund with only large (less risky) companies.
Similarly, bonds come with different risk and reward ratios. Longer-term bonds carry more risk and reward than shorter-term bonds because the farther out in time we go, the greater the uncertainty. In addition, corporate bonds generally involve more risk than government bonds, and some governments and some corporations are more risky than others. Municipalities obviously don’t have as much taxing power as state or federal governments, and so municipal bonds generally are riskier.
Keeping Our Nerve
At least since the Great Depression of the 1930s, we non-professional investors have had a wary relationship with stock markets. In modern times, that wariness has been reinforced by events like Black Friday and the Flash Crash.
Yet, the danger is not that stock markets will crash, but that we will sell our stocks and mutual funds too quickly when the news gets bad. That leads us to buy high, when everything is going well, and sell low, when it seems the financial world is coming to an end.
As we know, in retrospect at least, markets have always come back after crashing. It may take months or years, but they always come back. And, most companies also come back, although there’s less certainty about individual companies than about whole markets.
All of which gets us back to balanced funds. A less-volatile fund, like a balanced fund, will not drop as much when crashes occur, and so we should be less tempted to sell out in a hurry.
If the thought of being invested makes you nervous, you might want to look at balanced funds rather than putting together a portfolio of stock funds and bond funds. Having them combined in one fund means you will generally sleep better at night. Do remember, though, that your fund also will grow less during a bull market (when most stocks are going up).
What Should I Look For in Balanced Funds?
When shopping for a balanced fund (or funds), know your own needs first. If you’re young, you can afford to take more risks, since you have more time to recover if we have a crisis like the one that roiled the world in 2008. You’ll want a fund with more stocks than bonds, even as much as $2 in stocks for every $1 in bonds.
Older investors will want a bias toward bonds, toward greater safety. One rule of thumb investors have used for many years is to have the percentage of bonds equal your age in years. So, a 55-year old would aim for 55% bonds, and a 70-year old would aim for 70% in bonds. However, this is just a rule of thumb, so disregard it if you have another strategy.
You will find balanced funds actually allocate by ranges, rather than specific percentages or proportions. A fund that aims for 50% stocks might try to stay within a range of 45% to 55%, or even 40% to 60%. The same flexibility would usually extend to bond holdings.
When shopping for balanced funds, pay close attention to the expense ratio, the commission charged by the fund company. Also avoid, if you can, any fees that are levied when you buy or sell a fund. What may seem like small percentages here and there can–and do–add up to hefty amounts of money. Always shop around before buying.
Consider, too, buying a few funds rather than just one. Owning more than one fund provides diversification, which again increases the safety of your holdings (although sometimes at the expense of greater gains). You can buy balanced funds with different risk/reward profiles from the same fund company, or buy similar balanced funds from different fund companies.
What Will You Get Back?
Most balanced funds aim to generate both income and capital gains, income being your share of interest (from bonds) and dividends (from stocks), and capital gains (or losses) being the difference between the price at which you buy a stock or bond, and the price at which you sell it.
Compared with most other investment alternatives, balanced mutual funds give you a Goldilocks’ result–somewhere in the middle. Your gains and losses won’t be as bad or as good as those of stock-only or bond-only funds, but by combining stocks and bonds in one fund you should enjoy reasonable returns with reduced risk.
Next read about International Mutual Funds