Balanced Funds

The funds that employ hybrid investment philosophy of holding stocks, bonds and little bit of cash in the portfolio are called balanced funds. I classify balanced funds in two separate categories: fund of funds and stand-alone funds.

The fund of funds are funds that use other stock and bond funds from the same fund family or other fund families as underlying funds to allocate money between stocks and bonds. The managers of these fund of funds constantly watch asset levels in underlying funds and allocate new money so that target allocations remain constant. The good thing about this type of investment approach is that a single manager or a single fund management team does not make all of the investment decisions. The bad thing about this type of funds is that the fund of funds may add extra expenses on top of the expenses of the underlying funds. But, the low cost fund complexes like Vanguard do not charge any extra money on top of the expenses of the underlying funds.

The stand-alone balanced funds are the funds that invest in the stocks and bonds themselves to allocate the money. The good thing about stand-alone balanced funds is that they do not incur any extra expenses except the expenses of running the fund itself. The bad thing about stand-alone balanced funds is that one manager or management team makes all investment decisions.

I believe that the balanced funds are very good for people who are just starting to save and invest. The balanced funds provide less volatility than regular stock funds and the hybrid approach of the investments makes the ride smoother in the turbulent market conditions. For starters, the balanced fund provides instant diversification across all sectors and segments of the market.

One of the most important aspects of the balanced fund according to me is to ‘buy low and sell high’. The inherent architecture forces the fund manager to buy stocks when they are down or buy bonds when they are down to maintain constant target allocation. If the fund’s total assets are growing slowly as the time goes by, the fund manager must invest in the recently underperforming asset class to maintain target allocation. When the time comes to sell, the manager must sell the recently outperforming asset class and buy into the underperforming asset class. ‘Buy low and sell high’ is easy to say for us, but human nature has created a lot of ‘bought high and sold low or holding low’ situation across the investment world. I believe that the balanced funds help us overcome the pitfalls of the human emotions because the emotions are probably the biggest enemies of the investment success.