The perpetual question that investors are faced with is: Debt or Equities. As an investor should one opt for the volatility and to get high returns of equities? Or one should seek safety in debts while gathering moderate returns? While it is agreed both have their pros and cons, making this choice is difficult because we are always trying to get best of both the worlds. What if there was a way to invest in both - equities and debts, generate high returns with moderate risk? That sounds like perfection and that is what Balanced Funds strive to be.
What are Balanced Funds
These are a fund that constitutes of investments in equities, debt and occasional investments in short term money market all in a single fund. Balanced funds have a fixed percentage of investment in every asset class. An Equity Oriented Balanced Fund will have minimum 65% of equity and 35% of Debt investment. A Debt Oriented Balanced Fund will have 70 - 85% in debt and 15 - 30% investments in equity. A balanced fund is ideal for investors who are looking for a mix of safety, income and modest returns on their investment. The amounts that such a mutual fund invests into each asset class usually must remain within a set of minimum and maximum percentage according to the mandate of the fund.
Investing in a Balanced Fund
The first conflict that you may have in mind is instead of investing in one scheme and putting all eggs in one basket, it is probably better to invest individually in equity schemes and debt schemes. One of the myths concerning balanced funds is regarding the usage of the word ‘balanced’ and the confusion it tends to create. Investors are often under the illusion that the word balance connotes a 50:50 investment in debt and equities. This could not be far from the truth. The word ‘balance’ is used to denote that equities pose a certain risk to investments due to volatility of stock markets. Hence, to balance out the risk a certain percentage of debt investments are made. Let us have a look at the causes that makes balanced funds the best bet.
Reduces the Need to Diversify
Diversification is one aspect you have probably heard your financial planners and experts talk about when they discuss ‘successful ways of building a portfolio’. You are constantly thinking of ways to rebalance and diversify and moving around your funds and not allowing your investments to settle at one place. Investing in balanced funds reduces the need to constantly move around funds as it auto rebalances the allocation.
Asset Allocation has been done
Getting the asset allocation right is the biggest challenge for any investor. People spend years in the industry and still fail to be sure if the asset allocation will yield the right results as it has often been on a slippery ground. In balanced funds the asset allocation is carried out depending on the funds inclination to debts or equities. One of the major factors taken into consideration during asset allocation is the current age of the investor. The thumb rule states that “100 minus the age of the investor” will determine the percentage in equities.
In case of a balanced fund the investors just have to make a choice between a equity oriented balanced funds and debt oriented balanced funds. So if an investor is 40 years old then it is advisable to invest 60% (100-40=60) in equities and 40% in debts or instead invest in Equity oriented Balanced Funds. In another case if an investor is 60 years old, then it is advisable to invest 40% (60-100=40) in equities and 60% in debts or instead invest in debt oriented Balanced Funds. The existence of balanced funds does make the process of asset allocation fairly simple for investors.
While the Balance Funds rebalances the risk, the return difference between pure Diversified Equity Mutual Funds and Equity Oriented Balanced Funds is very less. See the chart below and you will notice that investors can still make good returns from Equity Oriented Balanced Funds by not taking as much risk as they would have taken in case of Diversified Equity Funds.
Promises Returns and Safety
It would be an ideal scenario if an investor could maximise returns by undertaking zero risk. While ideal scenario is hardly achievable in reality, investing in balanced funds brings us closer to that. The Balanced Fund balances out the risk imposed by equities by investing in debts and thus making this a moderately safe investment. Investors with varying risk appetite can invest in these funds without the fear of making loss.
It is often believed that one should not invest in funds based on future predicted performances. It is also said that past performances or stellar performances on paper are no guarantee for the future return. However, Advisors and experts often rely on the stability of the past performance of the funds. The sudden rise or drop in performances is never appreciated as it points towards volatility and the investors must try to avoid it. So let us take a look at the past performances of various types of Balanced Funds.
The table above shows balanced funds with various asset allocations and the category performances over the years. It can be seen in the last ten or so years the funds have delivered decent returns and in some cases stellar returns. None of the funds have depreciated despite dwindling markets in most parts of the last decade. Equity oriented Balanced Funds have given a stellar performance and generated cumulative returns of over 270%. So do you want to believe the experts? That is alright! but numbers do not lie and your bank accounts statements definitely do not.
Asset Allocation is often considered to be a personalized task where investors and advisors discuss and design a portfolio which is especially suited to the investor’s need. While Balanced Funds have asset allocation inbuilt in the funds they are not customized to fit into the individual investor’s needs. The changes in asset allocation takes places only when there are drastic changes in the market otherwise the asset allocation remains fixed despite the changes in investor’s need. Hence, these funds are not tailor made and cater to a larger objective and not to personalized objectives or needs. So an investor has to make an investment decision to design a portfolio with asset allocation which will generate the stellar returns as the funds or invest in Balanced Funds.
Balanced Funds are excellent option for investing for the long term. Balanced Funds make a good investment choice even in a falling market as the fixed returns on debts keep the returns steady. Therefore, investors with the help of the debt component often get ahead of falling markets. The investors again can take advantage of rising markets due to the exposure in equities. Hence, investors can gain much more than they have to lose by investing in balanced funds.
With automatic rebalancing of your portfolio and tax efficient returns, equity oriented Balanced Fund could be one of your best investing choices if you are able to take moderate risk. However, if you are a conservative investor then you can consider debt oriented balanced funds like Monthly Income Plans (MIP), etc. So, instead of pouring hours over different funds and schemes and figuring the right asset allocation and the ways to rebalance go for the Balanced Fund options and see your investments grow steadily.