Avoid the worst market swings with balanced funds.
What are balanced funds?
Balanced funds are also known as hybrid funds or asset allocation funds; they are mutual funds that contain a mix of core investment assets such as stocks, bonds, and cash. The asset allocation or “balance” remains relatively stable and serves a specific purpose or investment style. For example, a balanced fund might invest its portfolio in a conservative investment mix (relatively low risk) such as 40% stocks, 50% bonds, and 10% cash market.
How do balanced funds reduce market risk?
Balanced funds apply the timeless investment principle of diversification. When you diversify investments, you buy and hold securities that exhibit different performance behaviors and risk profiles. Best diversification practices typically involve investing in assets that are not highly correlated with one another. In other words, to build a diversified portfolio of mutual funds, you will need a range of fund types such as stocks and bonds, for example, that do not perform in the same way.
This is what balanced funds do for investors: they allow them to purchase one fully diversified fund. The only work required on the part of the investors is to choose the best balanced fund that aligns with their investment goal and risk tolerance.
Types of balanced funds
There are three main types of balanced funds:
Conservative balanced funds:
These funds typically maintain a balance between stocks, bonds, and cash suitable for conservative investors – those who are uncomfortable with large price fluctuations. The asset allocation in conservative balanced funds is usually around 35% stocks, 60% bonds, and 5% cash.
Moderate balanced funds:
These funds typically maintain a balance between stocks, bonds, and cash suitable for investors who do not mind some price volatility but not to the extent of a 100% stock fund. The typical asset allocation for a moderate balanced fund is about 65% stocks, 30% bonds, and 5% cash.
Aggressive balanced funds:
These balanced funds have the highest allocation to stocks and are suitable for investors who are comfortable with large price fluctuations. However, a small allocation to bonds can provide diversification that may lead to lower price volatility than the stock market, as measured by the S&P 500 index. The allocation for an aggressive balanced fund is typically around 85% stocks and 15% bonds.
Best balanced funds to reduce volatility
Due to their balanced design, all types of balanced funds can reduce volatility compared to a portfolio consisting of a 100% stock allocation. Therefore, the “best balanced fund” for any specific individual investor will depend on their investment goals and risk tolerance.
However, in general, funds that can perform best in down markets, when stock prices fall by more than 20%, are conservative balanced funds.
One of the best conservative balanced funds in the mutual fund world is Vanguard Wellesley Income (VWINX), which has a portfolio of 60/40 bonds to stocks. In 2008, when the S&P 500 index fell by -38.5%, VWINX had a more bearable return of -9.8%. Although negative returns are not a welcome experience for conservative investors, Wellesley’s performance in 2008 was significantly better than other funds in the same category, which lost an average of 18.61%.
Fast forward to 2019, and you can imagine how this fund could help you stay through the next down market. If you don’t mind taking on more risk, one of the top moderate allocation funds is Vanguard Wellington (VWELX), which has an allocation of about 65% stocks and 32% bonds.
Conclusion
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Investors should keep in mind that the asset allocation in balanced funds remains relatively constant. Therefore, they should not confuse them with target retirement funds, whose allocations change over time.
Disclaimer: The information provided on this site is for discussion purposes only, and should not be construed as investment advice. Under no circumstances does this information represent a recommendation to buy or sell securities.
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Sources:
Macrotrends. “S&P 500 Historical Annual Returns.”
Yahoo! Finance. “Vanguard Wellesley Income Fund Investor Shares (VWINX).”
Source: https://www.thebalancemoney.com/beat-volatility-with-the-best-balanced-funds-3958396
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