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Mutual Funds

The Beauty of Balance

If you like simplicity and want to tone down risk, you need funds that own stocks and bonds.

It seems way too easy. Buy one mutual fund and voilagrave; -- instant portfolio. But that's the essence of good balanced funds, which aim to help investors cut through the complexity of building and managing a portfolio with a ready-made mix of stocks, bonds and sometimes even a little cash.

It seems way too easy. Buy one mutual fund and voilagrave; -- instant portfolio. But that's the essence of good balanced funds, which aim to help investors cut through the complexity of building and managing a portfolio with a ready-made mix of stocks, bonds and sometimes even a little cash.

The classic balanced-fund cocktail blends 60% stocks and 40% interest-bearing IOUs. Some funds stick close to that allocation. Others give their managers some leeway to boost one category or another, depending on their views of the markets.

Because of the bond holdings, balanced funds are usually less volatile than pure stock funds. But balanced-fund returns should trail those of stock funds, particularly over the long haul. "You'll find that the highs of balanced funds aren't as high, but the payoff is that the lows aren't as low," says Bill Driscoll, a Plymouth, Mass., financial planner. Over the past ten years to May 1, balanced funds, on average, returned an annualized 7%, two percentage points per year behind Standard Poor's 500-stock index -- but with about one-third less volatility.


Balanced funds make sense for people who don't have enough money to build a balanced portfolio of stock and bond funds. They're also appropriate for investors who value simplicity and those who "want to avoid taking too much risk with a small amount of money," says Driscoll. If you have plenty of money, however, you would probably be better off building a diversified portfolio of the best stock and bond mutual funds that are most appropriate for your situation.

The good and not-so-good

Peek under the hood and you'll find that the composition of balanced funds varies widely. Blue-chip stocks and taxable, high-quality bonds are standard fare. But some funds invest in small companies, foreign stocks, junk bonds and even foreign debt. Some take on more risk with a heftier stock weighting, while others operate more conservatively, with less than 40% in stocks.

When you select a balanced fund, you should pay attention to fees and the manager's long-term track record, as well as the fund's basic strategy. One no-load balanced fund that we've recommended in the past is Vanguard Wellington (symbol VWELX; 800-635-1511). But Vanguard recently raised the initial minimum investment for Wellington from $3,000 to $10,000. With that kind of money, you can easily assemble a portfolio that holds three or four funds.

A fine no-load fund with a smaller minimum -- $2,500 -- is Fidelity Balanced (FBALX; 800-544-8544). From its 1986 inception, Balanced has returned an annualized 11%, on par with the SP 500. Over the past three years, it gained 17% annualized, two points a year ahead of the SP. Larry Rakers, who became lead manager in 2002, says he doesn't try to hit home runs with his stock picks, which recently made up 66% of the fund's $19.8 billion in assets. He says he "stalks" about 1,200 companies and, with the help of Fidelity's corps of analysts, invests in several hundred (578 at last report) that meet his value criteria. George Fischer, manager of the fund's bonds, is partial to investment-grade IOUs. The fund's annual expense ratio is an appealing 0.64%. (The average for all balanced funds is 1.11%.)


A fund with an unusual design is T. Rowe Price Personal Strategy Balanced (TRPBX; 800-638-5660). Its blueprint calls for 60% of assets in stocks, 30% in bonds and 10% in cash, although the fund recently had 66% of its assets in stocks. A committee led by Ned Notzon sets the overall asset balance, but the holdings mirror those of other Price funds. For example, Larry Puglia, manager of Blue Chip Growth, selects the large-company growth stocks for Balanced. Personal Strategy Balanced returned an annualized 14% over the past three years and 7% over the past five. Its three-year return places it in the top 7% of the category.

Tax-conscious investors should consider Vanguard TaxManaged Balanced (VTMFX). The fund invests slightly more than half of its assets in municipal bonds. With the rest, it seeks to mimic the Russell 1000, an index of the 1,000 largest publicly traded U.S. companies, while avoiding its highest-yielding stocks. The fund, which charges a minuscule 0.12% in annual expenses, gained 4% annualized over the past five years and 9% over the past three. Keep in mind that most of the income it distributes is tax-free. The fund levies a 1% redemption fee on shares sold within five years of purchase.

Not every balanced fund walks on the mild side. Take CGM Mutual (LOMMX; 800-345-4048), managed by Ken Heebner (see "Hot Hands, Hot Picks," on page 32). Over the past three years, the fund returned 23% annualized, versus a category average of 11% (over the past five years, its annualized return is 9%). But CGM Mutual is nearly three times more volatile than the average balanced fund. It has two-thirds of assets in stocks and the rest in bonds. But Heebner is no disciple of diversification. At last report, CGM Mutual held just 18 stocks, with big bets on energy and other natural-resources companies.

Heebner's record aside, CGM Mutual may be too turbulent for the kind of investor who would normally seek a balanced fund. But it might be a good choice for investors who want to hitch their wagon to Heebner but don't want to take huge chances. The fund is about one-third less volatile than Heebner's all-stock fund, CGM Focus (see The 25 Best Mutual Funds). Mutual's annual expense ratio is 1.09%.