Balanced funds invest in stocks and bonds at a set ratio — most often 60/40 stocks to bonds — with regular rebalancing back to the target mix. They’re also known as hybrid funds since they provide growth from equities and income from bonds. This allows investors to benefit from both the upside of stocks and the stability of bonds. A balanced fund’s appeal really comes down to its simplicity.
Generally, returns are more modest than those produced by all-equity funds, but so too are any losses. The combination of moderate returns and lower volatility make them ideal for long-term investors who can accept less growth in order to avoid the hassle of having to decide on multiple funds and the allocation to each.
Balanced funds have stood the test of time because they reliably serve their intended purpose and have done so for generations. Their investor appeal is considerable, as evidenced by the nearly $7 trillion invested in balanced funds globally (as of September 2023).
Origins of the balanced fund
The first balanced mutual fund in the U.S. was launched by financier Walter Morgan in December 1928, as the Industrial and Power Securities Company, then renamed the Wellington™ Fund in 1929. That original balanced fund still exists — now the Vanguard Wellington™ Fund — and consistently ranks well for performance and downside risk protection.
Key benefits of balanced funds
Balanced funds are intentionally structured as “set-it-and-forget-it” investment vehicles. They aim to achieve a balance between risk and return, which will vary from one investor to another. Investors only need to determine the asset mix best suited to their risk tolerance and investment objectives. Those more focused on growth will choose a higher equity allocation, while more conservative investors will opt for a greater allocation to bonds (and cash or cash equivalents as well).
A key advantage is the inherent diversification through holdings in stocks and bonds, which can smooth out longer-term performance, as the market moves through different cycles. Balanced funds’ multi-asset allocation enables investors to easily implement a relatively low-risk, high-reward investment strategy.
Another key advantage is the automatic rebalancing, which creates value over the long term while reducing the likelihood that emotions derail an investor’s ability to stay invested. It’s vitally important that investors are able to stick with their financial plan, if they’re going to achieve their long-term investing goals.
Lastly, many balanced funds are run fairly conservatively, by maintaining equity holdings in entirely (or mostly) well-known and long-established companies, as well as highly-rated government bonds. This often suits smaller, novice or more risk-averse investors.
Who should invest in a balanced fund?
- Investors who want a simple total portfolio solution that is easy to understand, track, and manage.
- New investors who want to start investing in the broader bond and equity markets with a core holding.
- Investors who don’t want to spend time fussing over fund selection or allocation choices and prefer automated rebalancing.
- Nervous or risk-averse investors who have trouble sticking with their investments during market downturns.
- Fee-sensitive investors will prefer a balanced fund over a more costly diversified portfolio of multiple funds.
The mechanics of a balanced fund
The main differentiator amongst balanced funds is the target allocation for equity and fixed income. Most common is a 60/40 split between stocks and bonds, but the mix will typically vary from 50 to 80 per cent in stocks and 20 to 50 per cent in bonds. There are some conservative balanced funds that hold more bonds than stocks.
Balanced fund holdings must be periodically rebalanced to their target component weights, but there is no firm rule regarding that frequency. Some have a schedule for rebalancing while others operate with a specific range beyond the target weights that triggers rebalancing.
Another important differentiator is that balanced funds can be active or passive. Active means a portfolio manager is paid to research, select and monitor individual stocks and bonds they choose, in an attempt to outperform the benchmark for the fund. With a passive balanced fund there’s a blended benchmark that consists of an equity index and a bond index, which determines the holdings of that fund. No investment decisions are made as the portfolio construction process is entirely rules based and dictated by the index constituents.
Historical performance
Balanced funds have tended to perform well during market downturns and economic recessions given their dual-pronged exposure to stocks and bonds, the latter of which protect the fund during periods of equity market weakness. And the converse is true when bond markets struggle and equities perform better.
It’s rare for stocks and bonds to both be down in the same year, which is what happened in 2022. The last time that occurred was in the 1960s. That being said, investors in balanced funds fared better than those invested in stock funds. And, after suffering one of their worst downfalls on record in 2022, balanced funds bounced back in 2023.
Rebalancing when prices move dramatically allows investors to naturally gain additional exposure to the more attractively-valued asset class, which can bolster long-term performance.
Potential pitfalls
While balanced funds are a great solution for some investors, there are some common criticisms levelled at them that prospective investors should consider.
The asset mix doesn’t change, which doesn’t work for investors who want to shift their allocation over time (to own more bonds as they near retirement, for example). That being said, investors can always transfer to a more conservative balanced fund.
Equity risk might be lower with balanced funds, but 50 to 80 per cent of a fund in stocks still means a fair amount of downside risk, even if bonds perform well. This is why it’s so critical that investors accurately assess their risk tolerance and invest accordingly.
Some fund managers are accused of leaving fixed income as an afterthought while they devote most of their time and effort to managing the equities. Accusations of closet indexing sometimes extend to the equity holdings as well, but investors must realize that closet indexing can happen beyond balanced funds. Closet indexing is problematic because investors face potentially unknown risks and are not being properly compensated for the cost of active management.
Getting the right mix
Balanced funds provide an easy and cost-efficient way to obtain diverse exposure to equities and bonds with automatic rebalancing that deliver steady lower-risk growth and income.
Barry Ritholtz, founder and chief investment officer of Ritholtz Wealth Management and a columnist for Bloomberg summed it up nicely when he said: “The perfect portfolio isn’t necessarily the one that generates the highest return — it’s the one you can live with.”
Investors should consult fund materials and ideally speak to an advisor to find the right balanced fund for their needs.
