The training wheels have fallen off balanced funds.
For years, many financial planners and investors derided funds that combined stock and bond investments as suitable only for beginners–if then. High fees and lackluster performance turned off others who might have liked balanced funds’ convenience.
Net purchases of balanced funds drooped from $14 billion in 1993 to $1.8 billion in 1995. By contrast, purchases of growth-stock funds bloomed from $21.4 billion to $37 billion.
Since then, however, balanced funds have staged a comeback, thanks to a volatile stock market and investors’ reassessments of their usefulness.
Balanced-fund purchases nearly tripled in 1996, while stock-fund purchases rose 73 percent, according to Investment Company Institute figures. In 1997, balanced-fund purchases topped $7.5 billion.
“Many people are touting balanced funds as being a good way to pull back from too much (stock market) exposure,” said John Collins, institute spokesman.
“Balanced funds make fine portfolios or bases for portfolios,” said Don Phillips, president of Chicago’s Morningstar Inc. mutual-fund research company. “They work especially well for smaller accounts, such as an initial IRA purchase, since they provide instant diversification.”
Because of their bond investments, balanced funds tend to hold up better in bad markets than pure stock funds.
“A good balanced fund is ideal for an investor who wants to sleep at night,” said Don Wilkinson of United Planners’ Financial Services of America in Newport Beach, Calif.
Only when stocks and bonds turn bad at the same time, as they did in the rising interest rate market of 1994, do balanced funds suffer worse.
Balanced funds also trail stock funds in booming markets. Over the past three years, balanced funds returned nearly 19 percent annually–a respectable performance but nearly 12 percentage points behind the Standard & Poor’s 500 stock index over the same period.
Robert Wacker, a fee-only planner in San Luis Obispo, Calif., says he recommends balanced funds for three types of clients: the timid, the harried and the stubborn.
Fearful investors or those new to the stock market can benefit from a balanced fund’s relatively tame ride.
Harried clients like the simplicity of a single fund handling both stock and bond investments, Wacker said. That relieves them from the annual task of buying and selling to rebalance their portfolio.
Balanced funds also help Wacker deal with stubborn clients who judge investments based only on their recent returns rather than against their peers, Wacker said.
These clients turn deaf ears to Wacker’s advice about the importance of diversification and how some asset classes will rise when others fall.
“If interest rates rise, they will think their bond funds are bad investments,” Wacker said. “If stocks drop, they will think their stock funds are bad investments.
The “forced marriage” of a balanced fund prevents them from singling out their stock and bond investments and overreacting to market moves, Wacker said. “It keeps them balanced when their natural inclination might cause them to make moves that would throw their portfolio out of balance,” he said.
Balanced funds have their drawbacks. The fund manager, rather than the investor, decides how to allocate money among stocks, bonds and cash. That makes it harder for investors to customize their portfolios if they want more or less stock exposure than the fund gives them.
“Most sophisticated investors who have enough assets to invest in three or more funds–perhaps $50,000 or more–can do better handling their own asset allocation,” said Sheldon Jacobs of the No-Load Fund Investor. “If you do it yourself, you’ll know exactly what you have.”
A comparison of average returns tells the tale. Last year, the average balanced fund returned 17.36 percent through Nov. 30. Someone who put together his or her own portfolio, with 60 percent in the average large-company stock fund and 40 percent in a typical intermediate bond fund, would have earned 18.6 percent, according to Morningstar figures.
The do-it-yourselfer would have also paid less. The average balanced fund charged a whopping 1.4 percent of assets, while the homemade portfolio would cost less than 1 percent a year.
The best balanced funds, however, offer much better-than-average returns at a low cost. Vanguard Wellington, for example, earned 21 percent in 1997 with a wispy 0.31 percent expense ratio. Over the past three years, the fund returned an average of 24 percent.
Balanced funds also can offer a taste of the wild side that conservative investors might otherwise eschew. Some fund managers soup up performance with emerging market stocks, junk bonds and derivatives–a far cry from the traditionally solid mix of 60 percent large-company stocks and 40 percent high-quality, intermediate-maturity bonds.
“Increasingly, managers are jacking up returns by buying more speculative stocks and lower-quality bonds,” Phillips said.
More conservative investors should stick to tamer funds that keep fixed percentages in stocks and bonds while boosting returns through good investment picking. Low turnover and low expenses are other hallmarks of a good quality balanced fund.
“Funds that make wide swings in their asset allocation or who have a predominance of smaller cap stocks, or who make big bets on particular asset classes should be avoided,” Wacker said.
