Balanced fund

From Bogleheads
Jump to: navigation, search

A balanced fund is a mutual fund that holds multiple asset classes. Typically these funds hold a stock component; a bond component, and in some instances, a cash component. [1] Some balanced funds restrict stock market investments to U.S. stocks; some funds include both U.S. stocks and international stocks. Some balanced funds may add non-traditional assets, such as precious metals and commodities, to traditional stock and bond assets.

Many balanced funds maintain a fixed asset allocation; some pursue a variable allocation policy, changing asset weightings according to market conditions. Target date funds are balanced funds that gradually change asset class weightings in harmony with an investor's supposed changing need for a lower risk profile over time.

Types of balanced funds

John Bogle on Selecting a Balanced Fund
  • Invest principally in mainstream funds.
  • Differentiate carefully among balanced funds’ various investment strategies.
  • Focus on long term returns, especially the year-to year variations in returns.
  • Know what makes the fund tick, especially the fund's technical factors: R-squared, beta, and gross yield.
  • Focus on the quality of a balanced fund's bond portfolio; the fund should hold high quality bonds.
  • Consider the costs of investment. Hold funds with the lowest expense ratio and lowest transaction costs.
-- Bogle on Mutual Funds

Balanced funds differ not only in investment strategy and costs (see quote box for John Bogle's criteria for selecting a balanced fund) but also in how the fund is structured. Multi-asset funds come in the following forms.

  • Balanced fund: Many balanced funds directly hold investments such as stocks and bonds. These type funds are designed to hold a specified range of asset allocations for each asset. Most balanced funds have a policy of investing between 60% - 65% stocks and 35% - 40% bonds; others have a more conservative allocation with 30% in stocks and 70% in bonds. Balanced funds can be either actively managed or indexed.
  • Fund-of-funds: A number of balanced funds do not hold individual securities, but rather hold shares in other mutual funds or exchange-traded funds. These types of funds are known as fund of funds. The underlying funds are usually funds offered by a fund family, but some fund-of-funds select mutual funds from numerous fund families. The SEC requires that fund-of-funds account for the expenses incurred by the underlying funds as acquired fund fees. The fund may also charge a direct expense ratio for managing the fund. The underlying funds can be either actively managed or indexed.
  • Life cycle fund: Life cycle funds are a group of funds holding varying ranges of fixed stock/bond allocations reflecting various risk levels. These are usually labeled as conservative, moderate, or aggressive portfolios. These funds are primarily designed for retirement and 529 college savings plans. [note 1] They are often structured as funds-of-funds. The underlying funds can be either actively managed or indexed.
  • Target date fund: These funds hold a mix of stocks and bonds that gradually shifts from higher stock allocations to lower stock allocations over time. The target date is set either for a given investor's projected retirement age or for a term ending at a time when the portfolio assets are needed for a targeted payout date. Thus, target date funds are primarily designed for retirement and 529 college savings plans. Different fund family's can have widely different asset allocations for the same target year, and differing glide paths for changing the asset allocation, so it is always advisable to check the underlying asset allocation of a target fund, rather than relying on a fund's target date. Target-date funds are often designed as funds-of-funds, with the underlying funds being either actively managed or indexed.
  • Asset allocation fund: Instead of holding fixed allocations to stocks, bonds, and cash, an asset allocation fund allows the manager to vary the fund allocations according to market conditions.
  • Managed payout funds: These funds are balanced funds that incorporate a formulaic spending policy into the fund’s investment policy. The investor retains access to the account balance, which will fluctuate with market performance. Neither principal nor payments are guaranteed. Managed payout funds generally fall into two basic categories:
  • Endowment-like funds. These funds are designed to generate regular payouts while striving to preserve (or in some cases grow) the principal. As with an endowment, the fund’s withdrawal strategy is based on a predefined rule, such as a percentage of the rolling three-year average of the fund’s net assets. (Vanguard adopts this approach for their managed payout fund).
  • Time-horizon funds. With this type of fund, payments are managed so as to exhaust the investor’s account over a specified period, for example 10, 20, or 30 years. The goal is to provide regular payouts from earnings and principal consistently over a given time period. The intent is that, at the end of the time period, the fund balance will be exhausted with the last payout. (Fidelity adopts this approach for their managed payout funds). [2]

Arguments in favor of balanced funds

Proponents of balanced funds make the following arguments.

  • Simplicity: According to Vanguard Research authors Bruno and Donaldson [3] a single balanced fund offers investors the convenience of a predefined asset allocation policy and risk control through automatic rebalancing and diversification.
  • Avoiding behavioral mistakes: Research indicates that when investors are confronted with a multitude of investment options they tend to not make decisions at all or choose to spread their assets across many investments with no strategic plan. [4] . A broadly diversified balanced fund is one solution that mitigates this conduct. Evidence from investor returns also indicates that investors are prone to chasing investment performance. Morningstar data for the ten year period ending December 31, 2010 reveals the difference in the returns investors received in equity funds, bond funds, and balanced funds in comparison with fund returns over the period. Equity investor returns lagged fund returns by about 1.4 percentage points; bond investor returns lagged fund returns by 1.2 percentage points. This compares with the lower differentials realized by balanced fund investors: a 0.54 percentage point differential for conservative balanced funds, and a 0.73 percentage differential for moderate balanced funds. Bruno and Donaldson assert that the balanced categories would seem to make investors less susceptible to performance chasing because each particular segment would not be separately visible within an investor’s portfolio. [5]
  • Automatic rebalancing: A balanced fund automatically rebalances to its stated asset allocation targets. This rebalancing keeps the investor’s desired risk exposure constant. Automatic rebalancing is especially important after periods of extreme market stress and uncertainty, times when investors find it difficult to reallocate funds into recent poor performing asset classes. In another Vanguard study, authors Davis and Pequet examined balanced investing during recessionary periods from 1926- 2010 for a monthly rebalanced, indexed 50% US equity/ 50% US bond portfolio. Such frequent regular rebalancing is much easier to implement for an automatically rebalanced balanced fund. Over this period, nominal and real returns for the portfolio during recessions and expansions are indicated in the following table:
Table 1. Annualized returns 1926 - 2010
50% US equity/50% US bonds[6]
Nominal returns in Recessions Nominal returns in Expansions Real returns in Recessions Real returns in Expansions
7.75% 9.90% 5.26% 5.59%

The historical averages mask recessionary periods when returns for this allocation were negative. These periods include the Great Depression; 1937; 1973; and the 2008 financial crisis. During these periods real return annual losses ranged between -5% and -15%. [7]

  • Vanguard balanced funds offer lower minimum investment: Vanguard offers low $1,000 minimum investment thresholds for a number of its fund of fund balanced fund offerings. For index investors, Vanguard sets the low minimum for its series of target date retirement funds. For investors who prefer actively managed portfolios, Vanguard offers its Star fund at the same low minimum investment. These low minimums make it easier for investors to begin an investment program and immediately establish an allocation policy with a broadly diversified portfolio.

Arguments against balanced funds

Critics of balanced funds make the following points.

  • One size fits all: A balanced fund’s selection and weighing of asset classes may not match an investor’s desired asset allocation policy. This may be true for investors wishing to tilt portfolios towards holding more value and/or more small cap stocks; hold more or less international stocks; or add additional asset classes, such as real estate, precious metals, commodities, inflation indexed bonds, or foreign bonds to the portfolio mix. In the case of a target date fund, the glide path may not correspond to an investor’s risk tolerance. For these investors, utilizing separate funds for each asset class is likely to be the proper strategy.
  • Tax considerations: In an attempt to increase a portfolio’s tax efficiency , investors having both taxable and tax-advantaged accounts may find holding individual asset class funds preferable to holding a single balanced fund. Under this scenario, tax-efficient investments (such as broad-market stock index funds/exchange-traded funds, low-yielding bond funds, and tax-managed funds) are held in taxable accounts and tax-inefficient investments (such as high yielding taxable bonds, REITs, and actively managed stock funds) are held in tax-advantaged accounts. Such an asset location policy also provides flexibility for the investor to strategically realize losses in the more volatile equity asset classes held in the taxable account. An additional tax factor involves qualifying for the foreign tax credit. The credit only applies to international stocks held in the taxable account. The optimal conditions for applying asset location to an investment policy are situations where an investor has both a sizable taxable account in relation to tax-advantaged accounts, and where an investor has a long holding period. [8]
  • Cost issues: Vanguard offers lower cost admiral shares for most of its suite of index funds for a minimum investment of $10,000. Admiral shares are not available for Vanguard balanced index funds structured as fund of funds (LifeStrategy funds, Target Retirement funds). Investors with higher account values may find it preferable to hold the admiral share individual asset class funds instead of the balanced fund.


  1. 529 savings plans usually refer to life cycle funds as Static portfolios or as multi-fund portfolios; 529 savings plans refer to target date funds as Age-Based funds.

See also


  1. Definition , from investopedia
  2. Bruno, Maria A., and Zilbering, Yan, Income in retirement: Common investment strategies, June, 2010
  3. Bruno, Maria A. and Donaldson, Scott J., Single fund investment options: Portfolio construction simplified for investors Vanguard Research, May 11, 2010
  4. Mottola, Gary R., and and Utkus, Stephen P. Can there be too much choice in a retirement savings plan? , Vanguard Research, (2003)
  5. Bruno, Maria A. and Donaldson, Scott J., Single fund investment options: Portfolio construction simplified for investors Vanguard Research, May 11, 2010
  6. Davis, Joseph, and Piquet,Daniel, Recessions and balanced portfolio returns Vanguard Research, October 6, 2011
  7. Davis, Joseph, and Piquet,Daniel,Recessions and balanced portfolio returns Vanguard Research, October 6, 2011
  8. Bruno, Maria A. and Donaldson, Scott J., Single fund investment options: Portfolio construction simplified for investors Vanguard Research, May 11, 2010

External links