In uncertain investing environments, many investors find that a mix of stocks and bonds can help mitigate their risks, says Richard Loth of The Fund Investor’s Schoolhouse.
Admittedly, in today’s investing environment the risks are very real. However, there are a number of strategies to mitigate and manage those risks.
Many financial professionals believe balanced mutual funds represent an investing strategy, which is relatively easy to understand and implement.
In the universe of mutual funds, hybrid is the technical term used to describe those funds with portfolios that are comprised of a mix of stocks and bonds. In general, fund company literature employs such terms as balanced, asset-allocation, and all-weather, to identify these funds in their offerings.
These are funds that tend to perform reasonably well during both favorable and unfavorable economic and market conditions. To simplify the terminology issue in this discussion, I’ll use the balanced label.
The actual stock and bond components in a balanced fund can be fixed or varied within a range of percentages in order to give the fund managers some investment flexibility. In most cases, the three most favored positions generally fall into three categories—moderate, conservative, and aggressive asset allocation.
Stock investments, historically, have had an average annual return of approximately 10%, while bond returns fall between 4% to 6%. Conservative allocation funds are for investors who are satisfied with a relatively lower return in exchange for more safety. On the other hand, the moderate allocation funds incur some risk, but attempt to reward investors with a higher return.
Obviously, the aggressive allocation funds attract the home-run hitters in the investment community, which in my way of thinking make these funds difficult to fit into a “balanced” investing strategy. As such, I’m going to leave them out of this discussion.
Conservative allocation funds are emphasizing defense over offense, while moderate allocation funds like a little more offense than defense. Don’t forget, however, that both allocations have stock and bond exposure in their portfolios; they simply differ on their allocation.
Depending on their risk tolerance and investment objectives, investors can use these funds to “balance” their risk-return positions in accordance with their personal risk tolerance and perceived market risks.
Balanced funds are not expected to produce spectacular returns, nor are they going to suffer dramatic losses. The stock-bond mix in these funds is a structural feature that cushions your investment in down markets and yet still provides reasonable growth in up markets. Used wisely, balanced funds represent good choices as core investments, no matter which allocation strategy you choose.
I’m going to suggest that you can create a virtual balanced fund by combining two balanced mutual funds, one with a moderate allocation and one with a conservative allocation. You would match the dollars invested in each fund as closely as possible with the intention of maintaining a stock-bond equilibrium, or reasonably close to that position.
However, when market conditions experience substantive change, you can redirect your reinvestment of fund distributions (dividends, interest, and capital gains) and/or new money to the most advantageous risk-return position.
For example, Fund ABC has a typical moderate allocation of 65% stock and 35% bond. Fund XYZ has a typical conservative allocation of 35% stock and 65% bond. In a sustained down market, you would reinvest both funds’ distributions and new money in Fund ABC to take advantage of buying more stocks at lower prices. In an overheated market, you would do the opposite by reinvesting both funds’ distributions and new money in Fund XYZ, buying more bonds and avoiding overpriced stocks.
My proposed “balanced-combo fund”, with an effective combined 50-50 stock-bond portfolio allocation, may seem a little tame for stock investors who perceive stronger growth prospects in larger equity positions. However, in the uncertain times we seem to be dealing with these days, modest returns accompanied by the relative safety of principal might look like a winning proposition.
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