Balanced Funds Don’t Inspire Fear or Greed. That’s Why They Are So Useful.
Posted July 14, 2018 12:55 a.m. EDT
The balanced fund is the vintage bicycle of investing.
It may be old-fashioned — the first balanced fund, Vanguard Wellington, began in 1929, while a precursor of the modern bike was patented in 1866 — but it endures because of its sturdy simplicity and its sheer usefulness.
And the old balanced fund is lately finding new fans. Since 2013, investor money has sloshed in, with the total assets in balanced funds swelling about 70 percent, to $1.7 trillion, according to EPFR Global in Cambridge, Massachusetts. In an age of ever-more-complicated mutual funds and exchange-traded funds, based on arcane strategies and obscure indexes, these folks are betting on the original set-it-and-forget-it investment.
A balanced fund invests in both stocks and bonds. It is balanced inasmuch as its traditional asset allocation is about 60 percent stocks and 40 percent bonds and cash, with the stocks providing return and the bonds reducing risk.
Russel J. Kinnel, director of manager research for Morningstar, said he once dismissed balanced funds as obsolete but has come to appreciate them.
“People do pretty well in balanced funds because balanced funds tend not to inspire fear or greed,” he said.
Balanced offerings can be actively managed, like Vanguard Wellington, T. Rowe Price Balanced, Mairs & Power Balanced or Oakmark Equity and Income, or indexed and passively managed, like the Vanguard Balanced Index Fund or iShares Core Growth Allocation ETF.
They can hew mostly to domestic securities, as does Vanguard Balanced, or they can bet bigger on international markets, as does T. Rowe Price Balanced. They are widely available — many large fund families offer them, including American Funds, BlackRock and Fidelity.
Balanced funds’ virtue is that their stodgy construction discourages investors from defeating themselves, Kinnel said.
Morningstar analyzes how mutual funds’ returns compare with those of the investors in those funds. Even when funds post good numbers investors do not necessarily reap the same returns, he said. That is because many people tend to buy and sell willy-nilly, jumping in when the market soars and bailing out when it crashes, rather than buying and staying put.
But people in balanced funds tend to be patient, helped by the funds’ smoother performance. As a result, the investors’ actual returns are more likely to match those of their funds.
In the 10 years through March, for example, investors in balanced funds, on average, had an actual asset-weighted 5.93 percent annualized return, according to Morningstar. That was better than the 5.63 percent annualized total return of those same funds, indicating that balanced fund investors typically avoided maladroit timing.
For mutual funds overall, the situation was reversed. Actual investor returns were 5.53 percent annualized, compared with a 5.79 percent total return for the funds. That shows that, in most other funds, investors had smaller returns because they bought high and sold low.
Jennifer Lane, a financial planner at Compass Planning Associates in Boston, said she recommends balanced funds because they really do encourage patience and prudence.
“We want to make sure our clients meet their savings goals, which means they have to stay in the market,” she said. “People will say they’re risk tolerant, but that really means they like return.”
When the stock market drops, they often panic and sell. Those who exit can miss out on a big chunk of the market’s rebound. By recommending balanced funds over ones with greater percentages of stocks, Lane said, she is nudging clients toward staying invested and sticking with their financial plans.
Target-date retirement funds have replaced balanced funds in some retirement plans. They do not stick to a relatively stable asset allocation, as balanced funds do. Instead, investors pick them based on when they are likely to retire, 2020, 2025, 2030 and so on. The funds change their asset allocation, typically reducing the share of stocks and increasing the share of bonds, as their investors approach that year.
The trouble with that approach, said Todd L. Rosenbluth, director of ETF and mutual fund research at CFRA, is that it assumes that everyone of the same age has the same risk tolerance and that people know in advance when they will retire. Balanced funds give flexibility to those who don’t fit comfortably into a target-date template, he said.
Another benefit of balanced funds is that their approximate 60/40 asset allocation, while not perfect, is good enough for many people, said Barry L. Ritholtz, chairman and chief investment officer of Ritholtz Wealth Management in New York and a columnist for Bloomberg. “The perfect portfolio isn’t necessarily the one that generates the highest return — it’s the one you can live with,” he said.
Witness what happened in 2008, when the S&P 500 dropped 37 percent. An investor in Vanguard Wellington would have ridden less of a roller coaster, as the fund fell just 22 percent that year.
One of the two managers of Wellington, Edward P. Bousa, expressed ambivalence about 2008. Bousa said he was pleased that he and John C. Keogh — Bousa oversees the stocks and Keogh the bonds — had outperformed the market. But he was disappointed that they had lost money for shareholders.
After all, Bousa said, they manage the fund defensively, with an aim of avoiding down years. That has been the fund’s goal for much of its existence. Wellington has lost money in only 18 of the 89 years since its birth. Over that time, it has returned an annualized average of 8.3 percent.
Bousa said he maintains a defensive position, on the equity side, in three ways. He seeks solid stocks with above-average dividend yields. He picks up growth companies that have fallen out of favor for reasons he judges to be temporary. And he hunts for opportunities in the capital-spending and demand-growth patterns of industries. “The idea is, in an area where there’s a lot of spending, there’s likely too much supply,” he said.
“In 2002, oil was $22 a barrel,” he said. “Supply was being constrained. The companies weren’t spending much money. But China was starting to emerge.” That meant oil prices were likely to rise, he said, so he increased the fund’s holdings in energy, a bet that paid off.
The stock portfolio has greater allocations of financial and health care stocks than competing funds, according to Morningstar. The fund’s international stock stake, at 13.5 percent of its assets, is roughly in line with competitors’.
Keogh said he tries to do three things with the fund’s bonds — contribute to the fund’s total return, damp the stocks’ volatility and provide insurance against bear markets.
“You can go in lots of directions to enhance your total return, like high-yield bonds, but that wouldn’t protect you in a down equity market,” he said.
Vanguard’s Balanced Index Fund differs from Wellington not only because it is passively managed but also because it has negligible international stock holdings — less than 1 percent of assets. It has returned an annualized average of 8.2 percent since its 1992 inception.
The T. Rowe Price Balanced Fund, in contrast, is more intrepid, lately investing about one-fifth of its assets in foreign stocks. It is overseen by T. Rowe Price’s asset allocation committee, said Charles M. Shriver, who is a chairman of the committee and the fund’s portfolio manager.
The committee meets monthly to decide how to divide the fund’s assets, typically among domestic and international stocks and bonds and cash. Shriver said the committee’s “building blocks” are T. Rowe Price’s “underlying actively managed strategies like high-yield bonds and U.S. growth and value stocks.” For example, Larry J. Puglia, who manages T. Rowe Price Blue Chip Growth, selects the balanced fund’s large-cap growth stocks. The fund has returned an annualized average of 9.6 percent since its 1939 inception.
The Mairs & Power Balanced Fund adds a Midwestern twist. Mairs & Power is based in St. Paul, Minnesota, and it favors its home region as a hunting ground, said Ronald L. Kaliebe, a manager of the fund. It has returned an annualized average of 9.5 percent since its inception in 1961.
“We’re blessed with a lot of great companies here, like 3M, where we’re a long-term investor,” he said.
Kaliebe said investing regionally lets him and his fellow managers cultivate a deeper knowledge of companies. They meet regularly with executives and often chat informally with lower-level employees.
“You can have a neighbor who’s an engineer somewhere or go to church with someone who works there,” he said. “That helps you build your investment mosaic.”
The local focus also leads to idiosyncratic opportunities, like bonds issued by Land O’Lakes, which the fund owns. “That’s a little bit of a one-off — it’s a locally based co-op of milk producers,” he said.
Hormel Foods, the meat-products company known for making Spam, is another holding based nearby, in Austin, Minnesota, just north of the Iowa state line. But not every investment comes from the Upper Midwest. “We can’t build the portfolio 100 percent in our home region because we don’t have that much energy and technology here,” Kaliebe said.
Suggest to Kaliebe that a balanced fund exhibits the unpretentious common sense that Midwesterners are known for and he is quick to agree.
“It’s nothing fancy,” he said. “But people can get overwhelmed by complexity in investing. A balanced fund offers more understandability.”