Why balanced funds are still sweet

@Money August 1, 2011: 3:12 PM ET

(MONEY Magazine) -- The fund industry never tires of concocting new products for investors looking for the perfect tradeoff between growth and stability. Absolute return, tactical allocation, target date ... those are just some of the impressive-sounding labels you're asked to decode.

But if you're looking for a way to diversify across risky and conservative assets, there's a simple solution that's been around for decades: the balanced fund.

Balanced means pretty much what it sounds like. The typical portfolio will have 60% in the volatile stock market, offset by 40% in steadier bonds. A balanced fund offers three key advantages:

It helps you stay steady:

Over the past decade, the average balanced fund has underperformed both U.S. stock and bond portfolios. Now here's the crucial wrinkle: When you look at how a typical investor in those funds did, balanced looks a lot better.

The research firm Morningstar tracks cash flows in and out of funds, and then adjusts for the amount of assets in each fund to get a truer picture of how much money the typical shareholder actually earns. Over the past decade, the returns of both stock fund and bond fund investors lag the fund averages. Balanced-fund investors, however, beat the average balanced fund a little -- and come close to what bond investors made during a good decade for fixed income.

How much diversification do you really need?

What's going on? First, it seems that balanced investors simply pick better funds; assets in the category are tilted toward solid classics from Vanguard, American Funds, and Fidelity. These investors may also be less likely to erode their gains with poorly timed trades, because balanced funds' moderate returns don't inspire fear or greed.

Christine Benz, Morningstar's director of personal finance, says the design of balanced funds may help people stick to a buy-and-hold approach.

"The all-in-one nature of the funds conceals the volatility of the underlying moving parts," she says.

If you pick a balanced fund that sticks to the same stock/bond mix -- such as the low-cost Vanguard Balanced Index (VBINX) -- you also get automatic rebalancing. When stocks rise in value, the fund increases its bond stake to get back to its target allocation and when stocks fall, it adds equities.

That saves you the hassle of rebalancing yourself and acts as a psychological crutch. It's hard to sell in a bull market or buy in a bear. Why not outsource your willpower?

It isn't customized, but may be close enough:

A classic rule of thumb is that the percentage you allocate to stocks should be 100 minus your age; a more aggressive version uses 110 to 120.

If that's the range, then a balanced fund that's 60% stocks has you in the right ballpark from age 40 to 60, your peak earning and saving years.

From that base, you can easily customize. Younger people who want more stock exposure, for example, could add an international or small-company fund.

Even if you succumb to poor timing decisions around the edges, the solid core of your portfolio will remain.

The alternatives aren't as simple as they look:

The most successful challengers to balanced funds these days are target-date funds. These funds also mix stocks and bonds, but hold out the hope of being true one-decision investments because they gradually shift out of stocks and into bonds as you get closer to retirement. (They may also hold foreign and alternative investments.)

Money 70: Best mutual funds and ETFs

But Theresa Hamacher, president of NICSA, a trade group of investment company professionals, says the funds require closer scrutiny than many realize.

"People thought that target-date funds guaranteed against losses as they neared their target date," she says.

In fact, most funds designed for near-retirees took big losses during the 2008 crash. Some funds for people retiring in 2015 have 65% in stocks, others just 30%. So you still have to think about (and monitor) your asset allocation when choosing a target fund. If you're already doing that homework, you may prefer the fine-tuning you get by combining balanced with other investments.

Besides Vanguard Balanced Index, check out two of our MONEY 70 recommendations. Vanguard Wellington (VWELX), which leans toward low-priced value stocks, can vary its stock weighting from 60% to 70%. T. Rowe Price Capital Appreciation (PRWCX) invests 50% to 70% in stocks.

A caveat about taxes: Larry Swedroe of BAM Advisor Services says that balanced isn't best if you have significant assets in both taxable and tax-deferred accounts.

In that case, you'd want to split your stock and bond holdings so that income-producing bonds are in the sheltered accounts. Until you're fortunate enough to have that problem, balanced is a one-size-fits-many solution To top of page

Overnight Avg Rate Latest Change Last Week
30 yr fixed3.80%3.88%
15 yr fixed3.20%3.23%
5/1 ARM3.84%3.88%
30 yr refi3.82%3.93%
15 yr refi3.20%3.23%
Rate data provided
by Bankrate.com
View rates in your area
Find personalized rates:
  • -->

    Most stock quote data provided by BATS. Market indices are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer. Morningstar: © 2018 Morningstar, Inc. All Rights Reserved. Factset: FactSet Research Systems Inc. 2018. All rights reserved. Chicago Mercantile Association: Certain market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. Dow Jones: The Dow Jones branded indices are proprietary to and are calculated, distributed and marketed by DJI Opco, a subsidiary of S&P Dow Jones Indices LLC and have been licensed for use to S&P Opco, LLC and CNN. Standard & Poor's and S&P are registered trademarks of Standard & Poor's Financial Services LLC and Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC. All content of the Dow Jones branded indices © S&P Dow Jones Indices LLC 2018 and/or its affiliates.