Balanced Funds

What is a 'Balanced Fund'

A balanced fund combines equity stock component, a bond component and sometimes a money market component in a single portfolio. Generally, these hybrid funds stick to a relatively fixed mix of stocks and bonds that reflects either a moderate, or higher equity, component, or conservative, or higher fixed-income, component orientation

These funds invest in a mix of equities and debt, giving the investor the best of both worlds. Balanced funds gain from a healthy dose of equities but the debt portion fortifies them against any downturn.

Balanced funds are suitable for a medium-term horizon and are ideal for investors who are looking for a mixture of safety, income and modest capital appreciation. The amounts this type of mutual fund invests into each asset class usually must remain within a set minimum and maximum.

Although they are in the "asset allocation" family, balanced fund portfolios do not materially change their asset mix. This is unlike life-cycle, target-date and actively managed asset-allocation funds, which make changes in response to an investor's changing risk-return appetite and age or overall investment market conditions.

Equities and Inflation

Investors who have dual investment objectives favour Balanced Funds. Typically, retirees or investors with low risk tolerance prefer these funds for growth that outpaces inflation and income that supplements current needs. While retirees generally scale back risk as age advances, many individuals recognize the need for equity exposure as life expectancies increase. Equities prevent erosion of purchasing power and help ensure long-term preservation of retirement corpus

Income Needs

The bond component of a balanced fund serves two purposes: creating an income stream and moderating portfolio volatility. Investment-grade bonds such as AAA corporate bonds and Money market instruments interest income from periodic payments, while large-company stocks offer dividend payouts to enhance yield. Retired investors may take distributions in cash to bolster income from pensions and personal savings.

Secondarily, bonds hold much less volatility than stocks. Bondholders have a claim against assets of a company while stocks represent ownership, bearing all inherent risk if bankruptcy occurs. Hence, debt security prices do not move in lockstep with equities, and their stability prevents wild swings in the share price of a balanced fund.

Taxation

Equity-oriented Balanced funds have a larger portion of their corpus (at least 65%) invested in stocks and qualify for the same tax treatment as equity funds. This means any capital gains are tax-free, if the investment is held for more than one year. However, these funds are more volatile due to the higher allocation to stocks.

Debt-oriented balanced funds are less volatile and suit those with a lower risk appetite. However, they offer lower returns and the gains are not eligible for tax exemption. If the investment is held for less than three years, the capital gains are treated as short term and taxed at the normal rates. But if the holding period exceeds three years, the gains are considered as long term and are taxed at 20% after indexation benefit, which can significantly reduce the tax.