Balanced Funds – The Right Balance for You?

The stock market volatility of the past several weeks, along with two substantial market declines over the past 10 years, has really brought investment diversification and balance into the spotlight.

As an investment advisor I have always practiced balance and diversification in the asset allocation strategies that I suggest for my clients.

Some investors might like the prospect of investing into a mutual fund that does this for you all in one package. Balanced mutual funds have been around for many years however they do come in many “flavors.”

Morningstar does not list a category entitled “Balanced Funds.” Rather there are several that encompass balanced funds:

• Conservative Allocation
• Moderate Allocation
• Aggressive Allocation

Additionally, depending upon your definition of a balanced fund, one could include the nine categories for Target Date funds as well.

This raises a key point, picking a balanced fund is not an easy task. Just like any mutual fund, investors need to review the fund’s objectives, understand the allocation and types of investment vehicles the fund will use, review the expense ratio, etc.

Morningstar’s Moderate Allocation category consists of funds that generally invest from 50% - 70% into equities, with the rest in bonds and cash. This is closest to the traditional 60/40 allocation I generally associate with a balanced fund. In this category, Morningstar has six Analyst Picks. A few collective observations regarding these six funds:

• Returns for calendar 2008 ranged from -18.41% to -33.57%. The S&P 500 index lost 37% that year.

• Returns for the past four weeks (ending August 12, 2011) have ranged from -4.89% to -9.46%. The S&P 500 lost 10.11% over the same period. Note the same funds were at the high and low ends of this range over both time periods.

• Based upon the most recent data (as of June 30, 2011) from Morningstar, the allocation to equities ranged from 46.45% to 73.29%. Again the fund with the lowest loss over both periods above had the lowest equity allocation and the fund with the worst loss the highest.

• Over the 10 year period ending July 31, 2011, the six funds had average annual returns ranging from 5.08% to 9.27%. This compares the S&P 500 which had an average annual return of 2.61% over this time period.

What does this mean to you as an investor? It means that balanced funds require review and analysis before purchasing and monitoring and evaluation while you own them.

One key point, assuming that a balanced fund is not your only investment, it is critical to look at the fund’s allocation to see how it fits with the rest of your holdings. Would the addition of a balanced fund cause your portfolio to be under or over weighted in stocks or fixed income? Is there undo overlap in the underlying holdings?

As with any mutual fund you want to look at who is in charge. Are they the folks who have accounted for the fund’s track record over a number of years? In short, this is no different than the selection of any other mutual fund or investment holding.

Regardless of whether you go the balanced fund route or create a balanced, diversified allocation from the individual holdings in your portfolio, the results noted above over the past 10 years at least speak to the benefits of diversification. While a balanced approach certainly will not always provide a better return than equities, you will generally find the road to be a bit less bumpy in terms of portfolio volatility.

Please feel free to contact me if I can be of help in reviewing your portfolio. Also please check out my contributions to the US News Smarter Investor Blog.