Understanding the so-called ‘balanced’ mutual fund
Richard LothInvesting WiselyIn the view of most financial professionals, including me, the use of one of the forms of a “balanced” fund provides a convenient, low-cost, and long-term approach to investing for retirement. A balanced fund is a mutual fund that seeks to provide some combination of growth, income, and preservation of capital. This is generally accomplished by investing in a mix of stocks, bonds, and money market instruments. Originally, a typical balanced fund would have a static weighting, or mix, of 60 percent stock and 40 percent bonds, and would be restricted to a maximum and minimum variance from this formula. I happen to believe that this 60/40 asset allocation is one that an investor, under most circumstances, could maintain for a lifetime. Pension funds, of the defined benefit variety, have used this approach for decades.Standard & Poor’s newsletter, “The Outlook,” quoted (May 10) Lou Harvey, president of Dalbar, Inc., a Boston-based mutual fund consulting firm as saying that ‘balanced funds are the ultimate by-and-hold vehicle. Our studies show that long-term average annual returns for balanced funds are about the same as for equity funds.”In recent years, the mutual fund industry, supported by many investment advisers, has been pushing a new breed of balanced funds. Essentially, these come in three different flavors: active asset allocation, life-style, and life-cycle or target funds.In the case of an active asset allocation fund, the portfolio manager is continually changing the asset mix according to his or her perception of the market environment. The objective is to maximize the fund’s total return within a stated risk position. I’m somewhat skeptical about this approach – transaction costs and the fund’s operating expense ratio will tend to be higher than average. And, fund management has to make a lot of right decisions. I’d prefer the steady Eddie static 60/40 approach.If you equate the term “lifestyle” with risk, you essentially have the definition of a life-style fund. So, if you’re someone who likes driving in the fast lane, you’ll opt for an aggressive growth stock life-style fund (high risk/high return). If you have a different view of life, i.e. how much risk you can tolerate, you would move to a slower-paced, conservative asset allocation fund (low risk/moderate return). Here again, I’m not convinced that this strategy, for most investors, is any better than the plain-vanilla static balanced fund.The increasingly popular life-cycle, or target, funds have their risk/return (asset mix) determined by age (as per the investor’s retirement date). They have a set portfolio that automatically changes as the years march on, starting out more aggressive and ending up more conservative. Lately, these simple “one-and-done” type funds have become important defined-contribution retirement plan investment options.If a life-cycle fund is the only alternative to doing nothing, which, unfortunately, is not an uncommon phenomenon for the general public, I’d give this investment vehicle my blessing. However, I don’t believe in using age as the principal criteria for making risk/return investment choices. One size cannot possibly fit all investors and giving up complete control, as well as interest in, your personal finances, is, I think, a mistake.Also, lifestyle and life-cycle funds are comprised of index-oriented or actively managed funds and are, thus, referred to as funds of funds. In some instances, this structure involves multiple layers of expenses, which can make these funds a bit costly.For those investors with limited time and financial experience, my suggestion would be to stick to the proven plain-vanilla variety of balanced fund as a major piece of your investment portfolio. As your investing skills develop, you can look to more variety in you investment mix to improve returns.The Investing Wisely column is written by Richard Loth, managing principal of Mentor Investing, an independent registered investment adviser. Loth can be reached by emailing email@example.com or calling 328-5591.Vail, Colorado
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