If you are thinking about investing, you may have heard financial experts and others recommend a balanced fund. Balanced funds are a popular choice for investors that want to reduce risk while still seeing some returns on their efforts. Find out what a balanced fund is, how it works, and whether it might be the right fit for you.
What Is a Balanced Fund?
A balanced fund is a type of hybrid mutual fund, meaning that the fund contains a diversified portfolio of more than one type of asset.
In the case of a balanced fund, these mixed assets include stocks and bonds (and sometimes money markets). The term “balance” comes into play due to the fund’s asset mix, which remains relatively static. The typical mix is composed of 60% stocks and 40% bonds.
This balanced portfolio provides the investor with a safety net if the market should experience a downturn. Sometimes a balanced fund is also called an asset allocation fund.
A balanced fund is best-suited to investors who are looking to take advantage of the market when it is performing well, while still having significant protection from an economic downturn. They are a great fit for retirees and more passive investors. Both of these types of investors benefit from the safety and low-to-medium-risk diversification that a balanced fund has to offer.
Balanced funds are also a great choice for people who consider themselves to be reactive. One big advantage of balanced investment approaches in general, even beyond balanced funds, is steadiness. Rather than seeing dramatic rises and falls in earnings, balanced funds tend to hold their value well and remain steady. This keeps more reactive investors from making premature decisions when the fund’s value drops.
Types of Balanced Funds
While all balanced funds follow the same basic structure, there are different types of funds that can serve different kinds of investors. An investor will need to choose a certain type of balanced fund depending on their specific financial situation and goals.
Here are the different kinds of balanced funds you can choose from:
- Conservative Balanced Funds: As the name implies, a conservative balanced fund is designed to minimize dramatic price swings. This is achieved through the precise allocation of assets optimized to remain steady. Typically more than half of the fund consists of bonds, with the remaining mix consisting of stocks and cash.
- Moderate Balanced Funds: This type of fund is designed for the investor who can tolerate some price fluctuation, but does not want to ride through dramatic highs and lows. Typically the asset mix for a moderately balanced fund has half stocks, with the remainder consisting of bonds and cash.
- Aggressive Balanced Funds: The aggressive balanced fund is not for the faint of heart. The asset mix in this type of balanced fund has been designed for the investor that can tolerate more dramatic price fluctuations. This is achieved through an asset mix that mostly consists of stocks, but has some bonds as well.
Advantages of a Balanced Fund
A balanced fund is a popular choice for many investors because it inherently has many advantages. Here are some of the reasons why you might want to consider a balanced fund.
Low Risk
While all investments inherently carry some risk, the smart diversification of balanced funds across low-to-medium-risk stocks and bonds provide some protection from the market’s extreme highs and lows.
Rather than actively attempting to diversify your portfolio, a balanced fund is plug-and-play. The fund is already diversified, allowing you to hold a variety of securities in different markets that will perform differently from one another at any given time. The investor can still build a portfolio that suits their financial goals by selecting the right type of balanced fund.
Behavior Moderation
Unless you are a highly seasoned investor, many financial experts recommend following a single guiding principle: slow and steady wins the race.
Monitoring your portfolio’s progress can be interesting, but it can also inspire you to make unwise decisions out of fear or greed. Balanced funds hold their value in a steady way — resisting the extreme highs and lows of the market. Instead, they encourage patience, which is the key to wealth for your average investor.
The steadiness of a balanced fund can help moderate the investor’s emotions and keep them from being reactive and making poor investment decisions in response to these extremes.
Minimized Tax Implications
Compared with other types of funds, balanced funds keep the sales of securities relatively low. This results in lower transaction costs and less likelihood of facing a capital gains tax, meaning that you minimize the amount of taxes you need to pay out for your fund each year. It also keeps everything consolidated. Because you are investing in a single fund, you will receive a single dividend check and capital gains check. This makes your tax preparation significantly easier than some other investment options.
Disadvantages of a Balanced Fund
Though balanced funds may be a popular choice, it is not the right fit for everyone. These are some of the disadvantages of a balanced fund and why you might not want to open one.
Asset Rigidity
If you are searching for a fund that will allow you to have a lot of control over your asset mix, then a balanced fund might not be for you. The asset ratio is relatively fixed in most balanced funds, and investors have little freedom when it comes to reallocating their assets. While periodically refreshing your portfolio is recommended by most financial experts, balanced funds are not designed for frequent buying and selling.
Lower Returns
If your goal as an investor is to play the market and make the highest returns possible, then a balanced fund is not the right choice for you. Inherently, a balanced fund is designed to keep returns moderate in exchange for being low risk and less volatile than other types of funds. The balanced fund is the ideal fit for a more passive, safe-minded investor, but it is not well-suited for the active investor that wants to take risks.
Fewer Tax Benefits
While balanced funds make your tax preparation and filing significantly easier, it isn’t the best option for shielding yourself from taxes. Because of the fund’s asset rigidity, it can be difficult to execute investment strategies that minimize taxes to the fullest extent.
One way you can optimize your tax efficiency with a balanced fund is by selecting a fund that is specifically designed and managed with the goal of shielding the investor from high tax rates. Some ways that a fund might do this is by investing more in tax-efficient municipal bonds rather than government bonds or investing in a way that minimizes taxable dividend income.
