I like balanced/hybrid funds.
The main reason I like balanced funds is that the balanced funds let investors allocate assets more efficiently among underlying asset classes. I believe this efficient asset allocation generates positive excess returns for investors. To understand the effects of this balanced/hybrid strategy I am going to throw some numbers at you below. I know there are a lot of numbers and the Math is tedious, but stay with me.
As always, when looking at the performance numbers, I will use Vanguard Index fund returns for comparison. We are going to look at the returns of 3 funds.
(1) The Vanguard Total Stock Market Index (VTSMX)
(2) The Vanguard Total Bond Market Index (VBMFX)
(3) The Vanguard Balanced Index (VBINX)
The Vanguard balanced index employs a 60/40 strategy. 60% of the balanced index basically mirrors total stock market index and the remaining 40% mirrors total bond market index.
Now lets look at the returns of these 3 funds for the past 10 years.
The Vanguard total stock market index returned 9.06% annually for the 10-year time period ending 3/31/2006. This turned the original $10,000 invested 10 years ago into $23,802.83 on the 3/31/2006.
The Vanguard total bond market index returned 6.02% annually for the 10-year time period ending 3/31/2006. This turned the original $10,000 invested 10 years ago into $17,937.01 on the 3/31/2006.
The Vanguard balanced index fund returned 8.24% annually for the 10-year time period ending 3/31/2006. This turned the original $10,000 invested 10 years ago into $22,073.00 on the 3/31/2006.
Now, here comes the interesting part. Let’s consider a situation where someone chose not to invest $10,000 into the Vanguard balanced index fund, but instead invested $6,000 and $4,000 separately into the Vanguard total stock market index fund and the Vanguard total bond market index fund respectively. How much money these separate investments would be worth after the same 10-year holding period? The $6,000 invested in the stocks would be worth $14,281.70 and the $4,000 invested in the bonds would be worth $7,174.80. The total of these two investment would be worth $14,281.70 + $7,174.80 = $21,456.50.
These calculations show that the balanced fund returned about $616 more. The initial investment was same in both situations: $6,000 in the total stock market index and $4,000 into the total bond market index. But the balanced fund investment came out ahead in the race.
As we can see from the calculations above, the balanced fund generated excess returns for the investor. With the balanced fund investment, the whole is greater than the sum of its parts. Why this happened? I believe that the balanced/hybrid mechanism generated some extra dollars for the investor. When the stock market went down, the balanced fund was forced to buy stocks by either selling the bonds and/or by directing the new money coming into the fund towards the stocks. When the stock market went up, the balanced strategy forced the mutual fund manager to either sell the stocks and/or direct the new money towards bonds to keep the fund in the intended target allocation.
Buy low and sell high. This is very easy said than done. The balanced funds achieve ‘buy low and sell high’ by the way they are formed. The balanced funds with fixed target allocation takes the human emotions out of the investment process, and that is exactly what most of the investors need to succeed in the in the market.