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Main Findings
Balanced funds are mutual funds that invest in a mix of stocks and bonds, intending to provide both income and capital appreciation. Balanced funds can benefit investors who are looking for a diversified and stable portfolio that can withstand market volatility.
A balanced fund is a hybrid fund that diversifies its portfolio among two or more asset classes, usually stocks and bonds.
The proportion of each asset class can vary depending on the fund's objective, strategy, and market conditions. Typically, a balanced fund follows a 60/40 allocation, meaning 60% of its assets are invested in stocks and 40% in bonds.
However, some funds may have more or less exposure to either asset class, depending on their risk profile and performance goals.
Why invest in a balanced fund?
A balanced fund can offer several advantages for investors who want a balanced portfolio of growth and income. Some of the benefits are:
Diversification
A balanced fund reduces the risk of losing money by spreading it across different asset classes that have different risk-return characteristics. For example, stocks tend to have higher returns but also higher volatility than bonds.
By combining them in a balanced fund, the investor can enjoy the upside potential of stocks while cushioning the downside impact of market fluctuations with bonds.
Convenience
A balanced fund simplifies the investment process by providing a ready-made portfolio that is professionally managed by a fund manager.
The investor does not need to worry about selecting individual securities, rebalancing the portfolio, or adjusting the asset allocation according to changing market conditions. The fund manager does all these tasks for the investor, saving time and effort.
Flexibility
A balanced fund can adapt to different market scenarios by adjusting its asset allocation accordingly. For example, if the stock market performs well, the fund manager may increase the stock exposure to capture more growth opportunities.
Conversely, if the bond market offers attractive yields, the fund manager may reduce the stock exposure and increase the bond exposure to generate more income.
How to calculate the return of a balanced fund?
The return of a balanced fund is the weighted average of the returns of its underlying asset classes. To calculate it, we need to know the following information:
- The percentage allocation of each asset class in the fund
- The return of each asset class over a given period
- The expense ratio of the fund
The formula is as follows:
Return of balanced fund = (Percentage allocation of stocks x Return of stocks) + (Percentage allocation of bonds x Return of bonds) - Expense ratio
For example, suppose we have a balanced fund that has 60% in stocks and 40% in bonds. The return of stocks over one year is 10%, and the return of bonds over one year is 5%. The expense ratio of the fund is 1%. The return of the balanced fund over one year is:
Return of balanced fund = (0.6 x 0.1) + (0.4 x 0.05) - 0.01
Return of balanced fund = 0.06 + 0.02 - 0.01
Return of balanced fund = 0.07 or 7%
How to calculate the return of a balanced fund using an example?
To illustrate how to calculate the return of a balanced fund using an example, let's use the following data:
Initial investment: $10,000
Percentage allocation: 60% in stocks and 40% in bonds
Return of stocks: 10%
Return of bonds: 5%
Expense ratio: 1%
Using the formula above, we can calculate the return of the balanced fund as follows:
Return of balanced fund = (0.6 x 0.1) + (0.4 x 0.05) - 0.01
Return of balanced fund = 0.07 or 7%
To find out how much money we will have at the end of one year, we need to multiply our initial investment by one plus the return of the balanced fund:
Final value = Initial investment x (1 + Return of balanced fund)
Final value = $10,000 x (1 + 0.07)
Final value = $10,000 x 1.07
Final value = $10,700
Therefore, by investing $10,000 in a balanced fund with a 60/40 allocation and an expense ratio of 1%, we will have $10,700 at the end of one year, which is a $700 profit or a 7% return.
Examples
Some examples of balanced funds are:
Vanguard Balanced Index Fund Admiral Shares (VBIAX)
This fund tracks the performance of a benchmark index that measures the investment return of 60% stocks and 40% bonds. The fund has a low expense ratio of 0.07% and a yield of 1.64%. The fund has a five-year annualized return of 11.76% as of December 31, 2021.
Fidelity Balanced Fund (FBALX)
This fund invests in a mix of stocks, bonds, and short-term investments, with the goal of providing income and capital appreciation. The fund has an expense ratio of 0.53% and a yield of 1.41%. The fund has a five-year annualized return of 12.01% as of December 31, 2021.
American Funds American Balanced Fund Class A (ABALX)
This fund invests in a combination of common stocks, preferred stocks, bonds, and cash equivalents, with the aim of preserving capital, providing income, and achieving long-term growth. The fund has an expense ratio of 0.59% and a yield of 1.77%. The fund has a five-year annualized return of 11.03% as of December 31, 2021.
Limitations
Balanced funds have some limitations that investors should be aware of, such as:
Lack of flexibility
Balanced funds have a fixed asset allocation that may not suit the changing needs and preferences of investors over time. For example, an investor who wants to increase their exposure to stocks or bonds may not be able to do so within a balanced fund.
Higher fees
Balanced funds may charge higher fees than index funds or exchange-traded funds (ETFs) that follow a similar strategy. For example, the average expense ratio for balanced funds was 0.84% in 2020, compared to 0.15% for index funds and 0.20% for ETFs.
Tax inefficiency
Balanced funds may generate more taxable income and capital gains than other types of funds, especially if they rebalance frequently or invest in high-yield bonds. This may reduce the after-tax returns for investors in taxable accounts.
Conclusion
Balanced funds are mutual funds that invest in a mix of stocks and bonds, intending to provide both income and capital appreciation. Balanced funds can benefit investors who are looking for a diversified and stable portfolio that can withstand market volatility.
However, balanced funds also have some drawbacks, such as lack of flexibility, higher fees, and tax inefficiency. Investors should consider their risk tolerance, time horizon, and investment objectives before choosing a balanced fund.
References
- Investopedia (2022). Balanced Fund: Definition, Investment Mix, Examples. https://www.investopedia.com/terms/b/balancedfund.asp
- Forbes Advisor (2023). What Is A Balanced Fund? https://www.forbes.com/advisor/investing/what-is-a-balanced-fund/
- Morningstar (n.d.). The Best Balanced Funds. https://www.morningstar.com/funds/best-balanced-funds
FAQ
A balanced fund is a type of mutual fund that includes a mix of stocks, bonds, and other securities in its portfolio. The goal is to provide both growth and income, which is achieved by balancing higher-risk growth assets with lower-risk income assets.
Balanced funds can be suitable for investors looking for moderate growth and are willing to tolerate some level of risk. They can also be a good choice for individuals seeking diversification across different types of investments.
Balanced funds manage risk by diversifying investments across different types of assets. This means that if one asset class performs poorly, the other asset classes may perform better and offset the losses.
A balanced fund maintains a relatively fixed asset allocation. A target-date fund, on the other hand, adjusts its asset allocation over time to become more conservative as the target date (usually retirement) approaches.
No, a balanced fund cannot guarantee returns. The performance of a balanced fund depends on the performance of the securities in its portfolio. While balanced funds aim to reduce risk through diversification, they still involve risk and the potential for loss.
