Are Balanced Funds Right for You?

When you cut through all the financial jargon, your investment decision comes down two things: how much do you want your investment to earn over some period of time and how much risk are you willing to assume to get to that goal?

Imagine a spectrum of investors. At one end there is the super-aggressive growth investor willing to endure stomach-churning peaks and valleys in the riskiest equities markets in order to watch his investment rocket skywards. At the other end the ultra-conservative type has one demand: that their investment income stream be predictable.

That first investor would never think of watering down his investment with bonds, nor would the second put herself in the position of losing sleep every time the Dow drops 100 points.  Their choices are easy.

Most of us, however, fall somewhere in between those two endpoints of pure high-octane stocks and coupon-clipping predictability. Our choices are not so easy. Could investing in balanced funds simplify the solution? What are the relative pros and cons of balanced funds? That’s what we’ll examine in today’s blog post.

What’s in a Balanced Fund?

For those of us in the middle of that risk-return spectrum, the logic of a balanced fund is intuitive.  Balanced funds offer some upside while limiting the downside.  The Vanguard Balanced Income Fund (VBINX), for example, offers a straightforward blend target of 60% equities and 40% bonds, with each category tracking the performance of a relevant benchmark index.  You know that if stocks go up you won’t completely lose out, but you also have a cushion if the market goes into meltdown.

Other balanced funds offer active approaches to a particular target.  The Oakmark Equity and Income Fund (OAKBX) maintains a range of 40-75% of total assets in equities at any one time (and up to 35% in non-U.S. assets), with up to 60% investable in high-quality government and corporate bonds. This means the fund’s managers will probably weight the portfolio in favor of stocks when they hear the running of the bulls, and pull back when they hear growling bears.

Another balanced fund strategy might hold a diversified pool of income sources. The Fifth Third Strategic Income Fund (MXIIX), for example, holds a mix of interest-bearing bonds, high-dividend common stocks, preferred stocks and closed-end investment companies. This caters to investors who want high income and a little bit of upside potential as a secondary aim.

I Don’t Want to Think About It!

Perhaps a balanced fund’s most important function is to minimize the number of things you, the investor, have to think about. That will either be appealing not depending on your approach to investing.

Let’s say that you enjoy reading the Financial Times. You’re up to date on the latest economic developments in India, the profitability of large U.S. banks and current oil prices. You research funds and decide to focus your expertise on the Matthews India Fund (MINDX), Alpine Dynamic Financial Services Fund (ADFSX) and Ivy Energy Fund A (IEYAX).  You’re satisfied because you realize that these three funds are likely to react to different market forces – so if you were wrong about the banks at least you still have upside potential from the other two.

“But wait!,” you say. “I may be clever, but I still need some downside protection in this investment.”  So you spend a weekend doing more fund research and find the Fidelity US Bond Fund (FBIDX), a nice conservative fund with a broad allocation to the bond market.  You then carve up your portfolio into four quadrants of 25% each so that you have three diversified equities exposures for a total of 75%, and a bond position of 25% to provide some balance.

If you read that last paragraph and thought – “hey, that sounds like fun!” – then you probably want the control, flexibility and intellectual stimulation that comes from doing your own asset allocation. If, however, that sounds like a giant headache, you may be a more appropriate candidate for a balanced fund.

There are plenty of factors that go into individual fund selection, and there is no substitute for careful evaluation. Consider your goals and risk tolerance before you make any decisions, and study the market. Knowing what types of funds are out there will give you a better sense of what the right move is for you.

Note: Funds referenced in this article are for illustrative purposes only.  The author does not have an investment position in any of the funds mentioned herein.