Balance: more than stirring in bonds

Beware of stock-and-bond blends that have been 'stitched together' and marketed as balanced funds, say experts. And know that 'balance' has several definitions.

In light of recent market turbulence, one of the first products ever offered by the US mutual-fund industry has taken on new importance. Balanced funds contain just about everything an investor needs, including cash holdings as well as stocks and bonds.

Such funds are perfect for investors "who do not like a lot of volatility," or dislike tracking financial markets, says Sheldon Jacobs, editor of the No-Load Fund Investor newsletter, and a longtime mutual-fund analyst.

Balanced funds date back to the 1950s, when investment firms wanted to sell bond products, but believed consumers weren't interested, Mr. Jacobs says. To generate a buzz, fund companies packaged those products with stocks and cash instruments to create one all-purpose, all-weather portfolio.

"Balanced funds are an appropriate core holding for just about anyone," says Heidi Hu, co-manager of the Transamerica Premier Balanced Fund in Los Angeles. "One nice thing about being in such a fund is that you don't have to do your own rebalancing of assets each year," she says. (A fund manager does that for you.)

While critics grumble that long-term performance of balanced funds leaves much to be desired, they can do well in short time frames. So far this year, a number of balanced funds have rung up impressive numbers. (See chart below.)

For example, the Oakmark Equity & Income Fund is up 12 percent through June 11, according to information firm Morningstar Inc. The Greenspring Fund is up 11 percent; the USAA Balanced Fund is up about 11 percent. By comparison, the Standard & Poor's 500 Index is down about 5 percent for the year.

Over time, however, balanced funds are clearly left in the dust by single-purpose funds, such as pure stock funds or even top-performing bond funds.

Before buying into a balanced fund, do your homework, says Chris Traulsen, a senior fund analyst with Morningstar. "You need to know if you are really getting into a balanced fund, or if you are really getting an asset-allocation fund."

The two look similar, but asset-allocation funds are usually not restricted to only stocks and bonds. They may hold other types of securities, such as real estate or gold. This flexibility, Mr. Traulsen says, may actually work better in periods of market instability, when managers have to make quick decisions regarding the impact of the economy on a fund.

Balanced funds usually have about 60 to 70 percent of their assets in stocks, says Traulsen. But they don't always stick to that range, and often chase the market. For example, balanced funds in general shifted towards bonds as the market fell last year. With the market now rebounding a bit, these funds are moving more toward stocks, he says.

Traulsen also recommends that investors find out what types of stocks and bonds are in a balanced fund's portfolio. Many funds try to temporarily juice up returns with hot-shot growth stocks. The problem is that those same growth stocks may help sink the fund when the market dips, as occurred in recent months.

A typical balanced-fund investor should aim for a blend of both growth and value stocks, Traulsen says. If people are very conservative, they should go for balanced funds with value stocks; if they're more aggressive, for a fund with growth stocks.

In addition, look for the lowest possible expense ratio, says Traulsen. The average ratio for balanced funds, according to Morningstar, is about 1.25 percent. But he says investors should consider funds with ratios closer to 1 percent.

Finally, avoid funds that have been "stitched together," he says. In other words, has a fund company merely taken an existing stock portfolio, and a bond portfolio, and mixed them together, marketing the new product as a new "balanced fund?" If so, an investor may be paying an inordinately high amount for funds that he or she could pay less for if taken out individually. One way to avoid this trap: Look for well-established balanced funds with experienced and highly regarded managers.

For his part, Jacobs advises clients, especially wealthier ones, to avoid balanced funds because of the bond component of the fund. "Most often the bonds are taxable bonds." Wealthier people "should be buying tax-free municipal bonds, to avoid unnecessary tax consequences," he says.

Most investors can easily create their own balanced portfolio without buying into a low-performing balanced fund, Jacobs notes. Simply buy into an equity fund that meets your long-term objectives. And then, buy into a bond fund, probably a muni-bond fund, that does the same.

Voila! You have built a balanced portfolio, he says.

(c) Copyright 2001. The Christian Science Monitor