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Investment report and calculatorMutual funds can offer a simplified way to diversify your portfolio. Rather than picking individual stocks, bonds or other securities to invest in, you can gain exposure to multiple investments and asset classes using a single mutual fund. A balanced fund is a common type of mutual fund that features a mix of both stocks and bonds. You can use these mutual funds to balance risk across your investments or generate income, but they aren’t all alike. If you’re considering an investment strategy that includes balanced funds, it’s helpful to know how they work.

Balanced Funds, Definition

A balanced fund is a mutual fund that includes both stocks and bonds. These funds can also be called hybrid funds or asset allocation funds.

This type of fund is referred to as balanced because it typically focuses on maintaining a specific balance or allocation between stock and bond holdings. For example, some balanced funds have a 60% allocation toward stocks and a 40% allocation to bonds.

These funds are designed to maintain their same allocation, or as close to it as possible, over time. That’s different from something like a target-date fund, which adjusts its asset allocation to become more conservative as you draw closer to your target retirement date.

Balanced funds are also distinct from equity mutual funds, which only hold stocks, and bond funds, which are allocated exclusively to bonds. Balanced funds can be index funds, meaning they’re passively managed and attempt to match the performance of a specific stock market index. Or they can be actively managed by a professional fund manager.

Balanced Funds: The Pros

There are several benefits balanced funds can offer to investors. The first is streamlined diversification.

Investing in a balanced fund can give you all-in-one exposure to stocks and bonds. If you’re more of a hands-off investor who isn’t interested in actively buying and selling securities, buying balanced funds can help you diversify your portfolio without a lot of heavy lifting.

Balanced funds themselves can also be diversified in what they hold. For example, funds that hold a higher percentage of stocks might appeal to you if you’re looking to take a more aggressive approach. Or you may veer toward a balanced fund with a higher bond concentration if you’re interested in minimizing risk or generating income.

You can also choose balanced funds that match your overall investment strategy. Index balanced funds, for instance, may appeal to you if you want to keep pace with a particular stock market index, versus trying to beat the market. Actively managed balanced funds, on the other hand, might interest you if you want to benefit from the fund manager’s expertise in choosing underlying investments.

A balanced fund can also help insulate your portfolio against stock market volatility. While these funds don’t offer 100% downside protection, having a mix of stocks and bonds means risk is spread out. If stocks are flagging, the bond allocation in a balanced fund could help to pick up the slack and vice versa if bond yields are unstable.

Balanced Funds: The Cons

Investor discuss a mutual fundWhile balanced funds could help with achieving investment goals, such as generating income and tempering risk, there are some potential downsides to keep in mind.

The first thing to consider is cost. When investing in mutual funds, it’s important to understand the fund’s expense ratio. This ratio represents the cost of owning the fund annually, expressed as a percentage. The higher the expense ratio, the more you’ll pay in fees to own it.

Balanced funds can sometimes carry higher expense ratios when they’re actively managed, compared to index funds or exchange-traded funds. If you’re looking at a higher expense ratio to invest in a balanced fund, you have to weigh that against its potential return performance to see if the cost is justified.

Another consideration that’s cost-related has to do with the placement of balanced funds inside tax-advantaged and taxable investment accounts. Ordinarily, it might make sense to place investments that have high growth potential, such as stocks, in a taxable account while putting income-producing stocks or bonds in a tax-advantaged account. Because of the nature of a balanced fund, you can’t separate the two, which could make tax planning more challenging.

You also have to consider how well a balanced fund is able to meet your needs over time. Balanced funds are designed by nature to be in the middle where risk is concerned. If you’re a younger investor with time on your side, taking a more aggressive approach that involves more risk could help you grow your portfolio faster. On the other hand, if you’re nearing retirement you may want to shrink your stock allocation.

Since balanced funds maintain more or less the same allocation over time, you may find that they don’t necessarily meet your needs or help you achieve your goals, based on where you are on your personal investing timeline.

How to Invest in Balanced Funds

Investing in balanced mutual funds is something you can do inside a tax-advantaged account, such as a 401(k) or individual retirement account, as well as a taxable brokerage account. Whether it makes sense to hold a balanced fund in a tax-advantaged account or an online brokerage account may depend on your investment goals and your overall tax strategy for drawing down those accounts in retirement.

When comparing balanced fund options, here are a few things to keep in mind:

  • The minimum investment to buy the fund
  • The fund’s expense ratio
  • Whether the fund utilizes an index or active management approach
  • The fund manager’s track record, in the case of actively managed funds
  • Which benchmark or index the fund tracks, in the case of index funds
  • How the fund is allocated between stocks and bonds
  • What type of stocks or bonds the fund includes
  • Whether the fund is rebalanced automatically
  • The fund’s historical performance and return averages

Remember, historical performance is not a certain predictor of how a balanced fund or any other investment may do in the future. But looking at a balanced fund’s history can give you an idea of how the fund has performed at different times during the market’s various cycles.

The Bottom Line

Stocks on screenBalanced mutual funds can offer an easy entry point to investing if you’re new to the market. And even if you’re an established investor, you may consider balanced funds as an addition to your portfolio if you want a simple way to diversify. When weighing balanced funds in the investment mix, remember to look at the fund’s underlying investments to make sure they align with your overall goals.

Tips for Investing

  • Consider talking to a financial advisor about balanced funds and how you may be able to use them in your financial plan. If you don’t have a financial advisor yet, finding one doesn’t have to be difficult. SmartAsset’s financial advisor matching tool can match you with up to three local financial advisors, and you can choose the one who is best for you. If you’re ready, get started now.
  • If you’re holding balanced funds in a taxable investment account, it’s helpful to view your investments at least once a year to see how well they’re performing. If you have some funds that aren’t doing as well as others or are losing money, you may consider employing a tax-loss harvesting strategy. Tax-loss harvesting means selling off some of your losing assets to offset gains from other investments in your portfolio.

Photo credit: ©iStock.com/KreativePics, ©iStock.com/sanjeri, ©iStock.com/filo

Rebecca Lake Rebecca Lake is a retirement, investing and estate planning expert who has been writing about personal finance for a decade. Her expertise in the finance niche also extends to home buying, credit cards, banking and small business. She's worked directly with several major financial and insurance brands, including Citibank, Discover and AIG and her writing has appeared online at U.S. News and World Report, CreditCards.com and Investopedia. Rebecca is a graduate of the University of South Carolina and she also attended Charleston Southern University as a graduate student. Originally from central Virginia, she now lives on the North Carolina coast along with her two children.
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