Let’s start with what balanced funds are.
Balanced fund combine stock components, bond components and sometimes money market components in a single portfolio. Generally, these hybrid funds stick to a relatively fixed mix of stocks and bonds that reflects either a moderate, or higher equity, component, or conservative, or higher fixed-income, component orientation.
Balanced funds are focused toward investors who are looking for a mixture of safety, income and modest capital appreciation. The amount this type of mutual fund invests into each asset class usually must remain within a set minimum and maximum.
Although, they are in the “asset allocation” family, balanced fund portfolios do not materially change their asset mix. This is unlike life-cycle, target-date and actively managed asset-allocation funds, which make changes in response to an investor’s changing risk-return appetite and age or overall investment market conditions.
Investors who have dual investment objectives favour balanced funds. Typically, retirees or investors with low risk tolerance utilize these funds for growth that outpaces inflation and provides an additional income that supplements current needs.
While retirees generally scale back risk as age advances, many individuals recognize the need for equity exposure as life expectancies increase. While the equity holdings of a balanced fund tend to lean toward large, dividend-paying companies, those issues typically provide long-term total returns that track the S&P 500 Index. Historically, inflation has averaged at about 3%, while the S&P 500 averaged at about 9.8% from 1928 through 2014. Equities prevent erosion of purchasing power and help to ensure long-term preservation of retirement nest eggs.
But, it is vital to remember that while investing in balanced funds is not without risk as their predominant focus is on equities. But, a good balanced fund can make your experience of investing in equities less painful by reducing volatility in returns.
Everybody is not comfortable with investing in mid-cap and small-cap stocks as they are risky. Different funds have different exposure to these stocks. UTI CCP Advantage Fund, for instance, has the highest allocation (among balanced funds) of 83.69% to large-cap stocks. Escorts Balanced Fund has invested 34.92% money in large-caps, the lowest in the category, as per the November 2014 data. The average allocation of balanced funds to large-caps is 61%. Go with funds whose investment preferences suit your risk profile. Therefore, it is important to select the right fund.
Once the right fund is selected, you are ready to enjoy a range of benefits –
The bond component of a balanced fund serves two purposes: creating an income stream and tempering portfolio volatility. Investment-grade bonds provide interest income from semi-annual payments, while large-company stocks offer quarterly dividend pay-outs to enhance yield. Retired investors may take distributions in cash to bolster income from pensions, personal savings and government subsidies.
Secondarily, bonds and treasuries hold much less volatility than stocks. Bondholders have a claim against assets of a company while stocks represent ownership, bearing all inherent risk if bankruptcy occurs. Hence, debt security prices do not move in lockstep with equities, and their stability prevents wild swings in the share price of a balanced fund.
Because balanced funds rarely must change their mix of stocks and bonds, they tend to have lower total expenses. For example, a balanced fund would have an expense ratio of only 0.19%. This is so because it minimizes the risk of selecting the wrong stocks or sectors as it can automatically spread an investor’s money across a variety of types of stocks. Also, balanced funds set-up by retirees allow investors to withdraw money periodically without upsetting the asset allocation.
Balanced funds provide a ready portfolio of two main asset classes, equity and debt, and obviate the need to buy separate equity and debt funds. Not only this, the all-important job of asset allocation is taken care of by the fund manager. Asset allocation involves maintaining the equity-debt ratio at a desired level. In this, you keep booking profit in the asset that is doing better and investing that money in the any other asset so that the ideal portfolio composition is not disturbed.
What’s more?
Balance funds are tax efficient. Any fund that invests more than 65% of the money in stocks is treated as an equity fund for taxation. Even the debt portion is taxed like equity.
In a debt fund, short-term capital gains are added to the income and taxed as per the person’s tax slab, while long-term capital gains (after three years) are taxed at 20% with indexation. It allows investors to be taxed on returns over and above the inflation rate by adjusting the purchase price of the securities for inflation. In equities, long-term capital gains (after one year) are not taxed. While as short-term gains are taxed at 15%.
Many enthusiasts and investment veterans believe that balanced funds are the perfect fit for you if you prefer good sleepover trailblazing returns.
However, it is an ideal choice of type of investment to go with for first time investors who do not wish to manage their own portfolios and have a low capacity to absorb risk.
