What Are Hybrid Funds?

Definition & Examples of Hybrid Funds

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Hybrid funds are mutual funds or ETFs that provide a combination of more than one underlying investment asset class. They can be made up of a combination of stocks, bonds, or cash.

Learn who should hold hybrid funds and when they are a good investment.

What Are Hybrid Funds?

Hybrid funds are mutual funds or exchange-traded funds (ETFs) that invest in more than one type of security, such as stocks and bonds. They allow investors to own a mix of different elements that typically exist in two or more funds by investing in a single mutual fund.

This makes hybrid funds valuable for investors who want a stand-alone option. They are also good funds for beginners or core holdings in a complete portfolio of mutual funds.

Alternate names: balanced funds, asset allocation funds

How Hybrid Funds Work

Hybrid funds usually hold a combination of stocks and bonds. Depending on the type of fund, the asset allocation can remain fixed or change over time.

Asset allocation refers to the percentage of the fund that is invested in stocks, bonds, or cash.

The fund will have a stated objective, such as aggressive, moderate, or conservative growth. This indicates both the level of risk and the type of growth the fund is likely to experience.

For many investors, it can make sense to buy mutual funds that focus on multiple objectives, asset classes, or security types rather than just one investment type. Hybrid funds allow investors to increase their investment diversification with a single holding.

Types of Hybrid Funds

There are two main types of hybrid funds: balanced funds and target-date funds.

Balanced Funds

The asset allocation in balanced funds remains fixed over time. These funds generally fall into one of three classifications.

  • Conservative funds hold more bonds and fewer stocks. They are safer investments with less likelihood of risk, as well as slower growth.
  • Moderate funds have a balanced allocation of assets for medium risk and medium growth. For example, a moderate fund could hold 65% stocks and 35% bonds.
  • Aggressive funds generally hold significantly more stocks than bonds. This generally makes them high-risk high-reward investments, with potential for lots of growth and lots of loss.

Target-Date Funds

When buying into a target-date fund, the investor chooses a year that is closest to the end of their investment objective. The asset allocation of the fund shifts over time in relation to the target date.

Target-date funds are sometimes known as lifecycle funds.

Initially, the fund will take a high-risk, high-reward investment strategy, allocating as much as 90% of assets to stocks. This increases the likelihood of early growth.

As the target date becomes closer, the asset allocation automatically shifts to become less risky, favoring conservative investments such as bonds. This slows the growth of the investment but also keeps your money safer.

Target-date funds often have a year in the name, such as Retirement 2040, to tell you what range of target dates it is appropriate for.

Target-date funds are often used for long-term financial planning, such as retirement or education savings accounts. The target date you select would be the year you plan to retire or send a child to school. The shift in asset allocation means that as you get closer to using the money, your investment becomes more conservative and minimizes the risk of loss.

Some 401(k) plans use target-date funds as their default for plan participants who don't select their investments.

Do I Need Hybrid Funds?

Hybrid funds are a good choice for many investors. They allow you to diversify with just one mutual fund. Beginners can use hybrid funds to get started investing, or they can be used as a core holding in a portfolio of mutual funds or ETFs.

However, like all investments, hybrid funds come with risks. Aggressive balanced funds, for example, can experience high growth, but they are also volatile. While greater stock allocation can make for greater performance in the long run, the higher relative risk (and lower returns in down markets) may be too volatile for some investors with lower risk tolerance.

If you are unsure whether hybrid funds are a good choice for you, a financial planner can help you identify your goals, assess your risk tolerance, and choose the right investments.

Key Takeaways

  • Hybrid funds are mutual funds or ETFs that provide a combination of more than one underlying investment asset class.
  • They can be made up of a combination of stocks, bonds, or cash.
  • Balanced funds and target-date funds are common types of hybrid funds.
  • Hybrid funds can be aggressive, conservative, or moderate depending on their asset allocation.