When you cut through all the financial jargon, the investment decision really comes down to this main consideration: how much do you want your investment to earn over some defined period of time and how much risk are you willing and able to assume in order 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; while at the other end the ultra-conservative type has one demand: that the income stream from the interest coupons on her investment be absolutely predictable in the timing and size of each payment. 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. What are the relative arguments for and against balanced funds as opposed to single-category stock or bond funds? That is our topic of focus here.
Given that so many of us are somewhere 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. For example the Vanguard Balanced Income Fund (VBINX) 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. For example 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. What this means is that the fund’s managers will look to weight the portfolio in favor of stocks when they hear the running of the bulls, to give investors more potential upside than they would have by staying at the baseline 60/40. Another balanced fund strategy may be the construction of a diversified pool of income sources: for example the Fifth Third Strategic Income Fund (MXIIX) holds a mix of interest-bearing bonds, high-dividend common stocks, preferred stocks and closed-end investment companies, catering to investors with high income needs but who still want a bit of upside potential as a secondary aim.
Perhaps the most important function a balanced fund serves, though, is to minimize the number of things you, the investor, have to think about. And that will either be appealing to you or not depending on your own approach to investing. Practically speaking there is nothing a balanced fund can do that an investor could not replicate on his or her own by constructing a portfolio of different stock and bond funds. For example: let’s say that you enjoy reading the Financial Times and are up to date on the latest economic developments in India, the return to profitability of large U.S. banks and the continued strength of oil prices. You do your research and come up with Matthews India Fund (MINDX), Alpine Dynamic Financial Services Fund (ADFSX) and Ivy Energy Fund A (IEYAX) as vehicles through which to take on exposure to your areas of expertise. You’re even more pleased 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 think I still need some downside protection in this investment. So back you go to your fund research and find 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.
How do you know which approach is right for you? 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 with different types of stock and bond funds. On the other hand if that sounds to you like more headache than it is worth, you may be a more appropriate candidate for a balanced fund.
As always there are many more things to think about at the level of individual fund selection, and there is no substitute for careful evaluation of the suitability of any investment for your own profile of return objectives, risk tolerance and other considerations. Acquainting yourself with alternative stock, bond and balanced fund offerings 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.
