Balanced Mutual Funds
Mutual funds are traditionally classified by the asset class of investments they own. Some mutual funds only own stocks; these are called equity funds. Some mutual funds only own bonds; these are called bond funds or fixed income funds. Some mutual funds own both stocks and bonds; these are called balanced funds or, less commonly, blended funds.
Why would a mutual fund want to own both stocks and bonds? Simply put, some investors don't want to deal with choosing from a wide variety of mutual funds. They want a single, all-encompassing choice that they can purchase regularly, offers a decent chance at a good return on their money, and is more likely to avoid major volatility when the world falls apart, even though this means less upside when we are in a bull market. A well-managed, balanced fund has the best chance at achieving these objectives because the bonds tend to hold their value better when stock prices fall. The stock market typically makes up for low-yield environments on the bonds, producing dividend yields that are competitive with corporate bond yields.
Be Careful to Watch the Overall Mutual Fund Expense Ratio
One of the biggest dangers of investing in a balanced fund is the possibility that the mutual fund expense ratio, which is the costs paid by the mutual fund on behalf of the mutual fund shareholders, might be higher than if you were to buy two separate funds, one an equity (stock) fund and one a fixed income (bond) fund. This may not bother you if you consider it an inconvenience fee -- after all, you only have to deal with a single investment, which has its own value. It's something, however, that should at least be considered.
As a general rule, all-inclusive, investors should strive to pay less than 1.50% per annum in management fees, expenses, and other costs when building an individually managed account that follows the same balanced strategy (something only affluent or high net worth investors are likely to do). Meanwhile, investors should try to pay between 1.25% and 1.50% when investing through a publicly traded, pooled balanced fund, which can come with a myriad of tax disadvantages and methodology problems if you aren't careful.
For example, the Vanguard Balanced Index Fund Investor Shares (ticker symbol VBINX), which keeps 60% of the money in U.S. stocks and 40% in U.S. bonds, has an expense ratio of only 0.25% annually but it also has huge embedded capital gains, meaning it would be foolish to buy it in a taxable brokerage account. In tax shelters such as a Roth IRA, such a fund proved to be a good investment between periods like 2000 and 2010 when it outperformed the Dow Jones Industrial Average as bond values, acting as a safety cushion following the stock market crash that coincided with the bursting of the dot-com bubble.
Understanding the Intelligent Strategy Behind Balanced Mutual Funds
The theoretical justification for a balanced portfolio goes far beyond just balanced mutual funds. The biggest advantage of the balanced approach is psychological, rooted in a discipline known as behavioral economics. Put in its most basic terms, investors are less likely to panic and do something dumb if their portfolio tends to hold its value. As irrational as it is, most investors would prefer slightly lower returns that came in smoother intervals than a higher return that came with massive drops and increases in value. Accepting this truth about human nature may hold the key to a good night's sleep and successful wealth accumulation.