Beat Volatility With the Best Balanced Funds
How Balanced Funds Can Reduce Market Risk
If you want to buy the best funds for a volatile market, balanced funds can be a smart tool to consider.
And when a bull market begins to experience a correction, or a full blown bear market, volatility (the ups and downs in security prices) will often become more pronounced and balanced funds can smooth out the edges to reduce volatility.
But what are balanced funds and how do they help investors reduce market risk and keep volatility to a minimum?
Balanced Funds Definition
Also called hybrid funds or asset allocation funds, balanced funds are mutual funds that hold a blend of underlying investment assets, such as stocks, bonds, and cash. The asset allocation, or "balance" of assets, remains relatively fixed and serves a stated purpose or investment style. For example, a conservative balanced fund might invest in a conservative (relatively low risk) mix of underlying investment assets, such as 40% stocks, 50% bonds, and 10% money market.
How Balanced Funds Reduce Market Risk
Balanced funds apply the timeless investing wisdom of diversification. When you diversify with investments, you are buying and holding securities with differing performance behaviors and risk profiles. The best diversification practices usually involve holding investments that are not highly correlated to each other. In different words, to do a good job of building a diversified portfolio of mutual funds, you'll need a combination of fund types, such as stocks and bonds for a simple example, that do not perform identically to each other.
This is what balanced funds do for investors: they enable them to buy one fund that is already diversified. The only real work involved for investors is to choose the best-balanced fund that fits their investment objective and risk tolerance.
Types of Balanced Funds
There are three primary types of balanced funds:
- Conservative Balanced Funds: These funds will typically hold a balance of stocks, bonds, and cash that is appropriate for conservative investors -- those that do not feel comfortable with wide swings in prices. The asset allocation of conservative balanced funds is usually around 35% stocks, 60% bonds, and 5% cash.
- Moderate Balanced Funds: These funds normally hold a balance of stocks, bonds, and cash that is appropriate for investors who don't mind some fluctuation in prices but not as much as a fund with a 100% allocation to stocks. A typical asset allocation for a moderately balanced fund is 65% stocks, 30% bonds, and 5% cash.
- Aggressive Balanced Funds: These balanced funds will have the highest allocation to stocks and are appropriate for investors who are comfortable with wide swings in prices. However, a small allocation to bonds can offer diversification that can result in price volatility that is lower than the stock market, as measured by the S&P 500 index. An aggressive balanced fund will typically have an allocation of approximately 85% stocks and 15% bonds.
Investors should keep in mind that the asset allocation for balanced funds remains relatively fixed. Therefore, they shouldn't be confused with target-date retirement funds, which have allocations that change over time.
Best Balanced Funds to Reduce Volatility
By their balanced design, all types of balanced funds can reduce volatility, as compared to a portfolio that is comprised of 100% allocation to stocks. Therefore the "best-balanced fund" for any given individual investor will depend on that investor's investment objective and tolerance for risk.
However, in general, the funds that can perform best in bear markets, when stock prices fall more than 20%, is conservative balanced funds.
One of the best conservative funds in the mutual fund universe is Vanguard Wellesley Income (VWINX). In 2008, when the S&P 500 index had a massive drop of -37%, VWINX had a more tolerable return of -9.8%. Although a negative return is not a welcome experience for conservative investors, this 2008 return beat 90% of other conservative allocation funds.
For a broader perspective, the 15-year annualized return through December 31, 2015, is an amazing 6.8%, which beats 97% of conservative allocation funds.
VWINX has an asset allocation of approximately 38% stocks, 60% bonds, and 2% cash.
If you don't mind taking a bit more risk, one of the best moderate allocation funds is Vanguard Wellington (VWELX), which has an allocation of approximately 65% stocks, 34% bonds, and 1% cash.
Disclaimer: The information on this site is provided for discussion purposes only, and should not be misconstrued as investment advice. Under no circumstances does this information represent a recommendation to buy or sell securities.