Balanced Fund

A balanced fund is a type of mutual fund that invests in a mix of equity and debt instruments, also known as a hybrid fund. Balanced funds are a good option for investors who want to diversify their investments while also mitigating risk.
EXPLORE FUNDS
Balanced Funds in Mutual Funds
EXPLORE FUNDS
4 mins
25-December-2024

Balanced mutual funds are a type of hybrid mutual fund that combines equity and debt instruments to provide a balanced investment approach. These funds aim to strike an equilibrium between risk and return, making them suitable for investors seeking a diversified portfolio. By allocating investments across equities for growth and debt for stability, balanced mutual funds cater to those who wish to mitigate risks associated with market volatility. Their dual nature ensures both capital appreciation and steady income, making them an excellent choice for moderate-risk investors.

This article covers basic details about balanced funds, how balanced funds work, features of balanced funds and more.

What is balanced fund?

A balanced fund, often referred to as a hybrid fund, is a mutual fund that invests in a combination of stocks and bonds to offer a blend of growth and income. These funds maintain a predetermined asset allocation, commonly around 70% equities and 30% bonds, to achieve diversification and stability. By investing in equities, balanced funds aim for capital appreciation, while the bond allocation provides consistent income and reduces overall risk. This strategic mix ensures a balanced approach to investing, making these funds an ideal choice for individuals seeking moderate risk with steady returns. Balanced funds cater to investors who value diversification and prefer a single investment vehicle to achieve multiple financial objectives.

Features of balanced funds

  • Portfolio diversification: Balanced funds enable investors to diversify their portfolio by investing in a range of instruments such as equities and bonds.
  • Potential for decent returns: Balanced funds have the potential to generate substantial returns since they allocate a significant portion to equities.
  • Automatic portfolio rebalancing: Balanced funds are designed to automatically rebalance your portfolio, which can be advantageous during market instability. Fund managers sell equity holdings to maintain the fund's desired level and vice versa.

How does a balanced mutual fund work?

Balanced mutual funds, also known as hybrid funds, operate by investing in a mix of equity and debt instruments to achieve a balanced approach to risk and return. These funds are structured to provide capital appreciation through equity investments while offering income stability through debt securities. The allocation between these asset classes typically adheres to a pre-defined ratio, such as 60% in equities and 40% in debt, although this can vary based on the fund's objectives.

The equity component targets long-term growth by investing in shares of companies across sectors and market capitalisations. This portion benefits from market appreciation but carries inherent risks of volatility. On the other hand, the debt component includes instruments like government bonds, corporate debentures, and treasury bills, which provide fixed returns and help cushion against market fluctuations.

Balanced mutual funds are actively managed by fund managers who continuously monitor market conditions and adjust the portfolio to optimise returns while maintaining the desired risk balance. For instance, during bullish markets, fund managers may slightly increase equity exposure, whereas in bearish phases, they may lean more towards debt.

These funds are ideal for investors seeking diversification and moderate risk. By combining equity and debt, balanced mutual funds aim to deliver stable returns over time while mitigating sharp market downturns. This makes them a suitable option for individuals looking to achieve both capital growth and steady income without the need to manage multiple investments.

Advantages of balanced funds

Here are some advantages investing in balanced mutual funds:

  1. Diversification: Balanced funds automatically diversify your investments across asset classes, reducing the risk associated with investing in a single asset type.
  2. Risk Management: The combination of equities and debt helps manage market volatility. During periods of market turbulence, the debt component can act as a stabiliser.
  3. Professional Management: Balanced funds are actively managed by experienced fund managers who make informed decisions about asset allocation to optimise returns.
  4. Simplified Investing: For investors looking for an all-in-one solution, balanced funds provide a simplified way to access equity and debt markets without the need for managing multiple investment.
  5. Tax savings:
    • Similar to debt funds: Balanced funds, especially those with a higher debt allocation (75% or more), are taxed similarly to debt funds. This can be beneficial for tax-conscious investors.
    • Long-term capital gains: Investments held for 3 years or more in balanced funds qualify for Long-Term Capital Gains (LTCG) benefits. LTCG on balanced funds are taxed at a rate of 20% (plus applicable cess and surcharge) with the benefit of indexation.
    • Indexation benefit: Indexation allows you to adjust the purchase price of your investment for inflation, potentially reducing your taxable capital gains. This can be particularly advantageous for long-term investors in balanced funds.
  6. Protection against inflation:
    • Debt component: Balanced funds typically hold a significant portion of their assets in debt instruments like bonds and government securities. These investments offer regular interest payments, which can help hedge against inflation to some extent.
    • Equity component: While the debt portion provides stability, the equity component in balanced funds offers the potential for capital appreciation over the long term. This growth can potentially outpace inflation, helping to preserve the purchasing power of your investment.
  7. Rebalancing of assets:
    • Active management: Balanced funds are actively managed by fund managers. These managers strategically allocate assets between equity and debt, aiming to maintain a target asset allocation.
    • Maintaining balance: Over time, market movements can cause the weightings of equity and debt in the fund to drift from the target ratio.
    • Periodic rebalancing: Fund managers periodically rebalance the portfolio by buying or selling assets to restore the desired asset allocation. This helps maintain the fund's risk profile and investment objective.

Who are balanced funds suitable for?

Balanced funds cater to a wide range of investors. They are ideal for those who:

  • Are looking for capital preservation with moderate risk.
  • Seek a steady income stream along with the potential for capital appreciation.
  • Want a simplified investment approach.
  • Don't have the time or expertise to manage multiple investment options.
  • Are looking for diversification without the need to track different securities.

Taxation of balanced funds

Balanced funds capital gains are taxed based on their equity-debt orientation. Equity-based balanced funds (if equity component exceeds 65%) are taxed like pure equity funds. Long-term capital gains (LTCG) earned on the sale of mutual fund units after a holding period of 1 year are tax-free up to Rs. 1.25 lakh. LTCG exceeding Rs. 1.25 lakh is taxed at 12.5%, excluding the indexation benefit. Short-term capital gains, which are earned on the redemption of units before a holding period of 1 year, are taxed at a rate of 20%. Debt-based balanced funds are taxed like debt funds. STCG earned on investments held for less than 3 years are taxed according to one’s applicable tax slab. LTCG earned on redeeming units after 3 years are taxed at 20%, along with indexation benefits.

Disadvantages of balanced funds

  1. Moderate returns: Balanced funds may not generate returns as high as pure equity funds during bull markets, limiting the growth potential.
  2. Fees: Balanced funds typically come with management fees like almost other types of mutual funds, which can reduce the overall returns.
  3. Interest rate risk: The debt component of balanced funds is exposed to interest rate fluctuations, which can impact the returns from the debt portion.
  4. Lack of customisation: Balanced funds have predetermined asset allocation ratios that may not align with your specific risk tolerance or financial goals.

List of balanced funds in India sorted by returns

Things to Consider When Investing in a Balanced Fund

When contemplating investment in balanced mutual funds, several key considerations merit attention:

  • Expense Ratio: Hybrid or balanced funds, like other mutual funds, entail an expense ratio. This percentage represents the fee charged by the asset management company for its services. A higher expense ratio directly impacts the overall investment cost.
  • Past Performance Evaluation: Prospective investors should diligently assess the historical performance of a balanced fund. While past performance is crucial for insights, it doesn't guarantee future returns. Nevertheless, analysing a fund's track record provides a rough estimate of potential returns.
  • Risk Assessment: Although balanced funds are perceived as less risky than equity funds, inherent risks persist in all mutual fund investments. Investors must carefully evaluate their risk tolerance before committing to any investment.
  • Fund Manager's Expertise: Navigating funds through market fluctuations demands experience. A seasoned fund manager brings valuable knowledge to tackle market volatility and optimise returns. Investors benefit from a fund manager with a track record of managing funds effectively.

Conclusion

Balanced funds can be a valuable addition to your investment portfolio. Balanced mutual funds offer an attractive middle ground for investors, allowing them to enjoy the best of both worlds. While they may not deliver the same high returns as pure equity funds, they provide a balance between growth and stability. It is essential to assess your financial goals, risk tolerance, and investment horizon to determine if balanced funds align with your needs.

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Frequently Asked Questions

What is the difference between a balanced and growth mutual fund?

Balanced mutual funds invest in both equity and debt instruments, providing a mix of growth and stability with moderate risk. Growth mutual funds primarily focus on equity investments, targeting capital appreciation over time but involving higher risk due to greater exposure to market volatility.

What are the risks of balanced mutual funds?

Balanced mutual funds face market risks from their equity portion, which can lead to volatility during downturns. The debt component is subject to interest rate and credit risks, potentially affecting returns. Although they offer diversification, these funds may not fully eliminate the impact of broader economic fluctuations.

What is the asset allocation of a balanced mutual fund?

A balanced mutual fund typically maintains a mix of equity and debt instruments. The precise allocation varies, but it aims to strike a balance between potential growth and risk mitigation.

Is balanced mutual fund investment safe?

While balanced funds are designed to moderate risk by diversifying across asset classes, no investment is entirely risk-free. Investors should assess their risk tolerance and financial goals before considering balanced funds.

What is the difference between a balanced fund and a balanced advantage fund?

A balanced mutual fund maintains a predetermined mix of debt and equity investments, while a balanced advantage fund dynamically adjusts its equity exposure based on the prevailing market valuations.

Which is better equity or balanced fund?

The choice between equity and balanced funds depends on individual investor preferences and risk tolerance. Equity funds offer higher growth potential with increased risk, while balanced funds provide a mix of growth and stability.

Are balanced funds a good investment?

Balanced funds can be a suitable investment for those seeking a mix of growth potential and capital preservation. They offer diversification by investing in both stocks and bonds, potentially reducing overall portfolio risk. However, investors should carefully assess their risk tolerance and investment objectives before choosing balanced funds.

What is the interest rate of balanced fund?

The interest rate of a balanced fund varies depending on the performance of the underlying assets, such as stocks and bonds. Balanced funds do not offer a fixed interest rate like traditional fixed-income investments; instead, returns are determined by market fluctuations. Investors should review historical performance and consider future market expectations when evaluating potential returns.

What is the disadvantage of balanced funds?

A key disadvantage of balanced funds is their potential to deliver lower returns compared to pure equity funds during bullish markets. Moreover, their dual exposure to both stocks and bonds can result in underperformance during specific market conditions. Investors should carefully evaluate the fund's allocation strategy and align it with their risk-return preferences before investing

Is balanced fund tax free?

Balanced funds are not tax-free; investors may be subject to taxes on capital gains, dividends, and interest income generated by the fund. Capital gains taxes apply when investors sell their fund units at a profit, while dividends and interest income are taxed as per the individual's tax bracket. However, certain types of balanced funds, such as those investing in government securities, may offer tax benefits under specific provisions.

Who should invest in balanced mutual funds?

Balanced mutual funds are suitable for investors looking for a balanced approach to investing, combining growth potential with income generation and capital preservation. They may appeal to investors with moderate risk tolerance seeking diversification across asset classes. Individuals approaching retirement or those with shorter investment horizons may also find balanced funds attractive due to their balanced risk-return profile.

How do balanced funds differ from other hybrid funds?

Balanced Funds maintain a relatively fixed mix of stocks and bonds, unlike life-cycle or target-date funds, which adjust their asset allocation based on the investor's age or market conditions.

How does the equity component of a Balanced Fund help with inflation?

The equity portion helps prevent the erosion of purchasing power by providing growth that can outpace inflation, which is especially important for long-term preservation of retirement savings.

What role does the bond component play in a balanced fund?

The bond component generates income through interest and dividends and helps reduce portfolio volatility, offering a stable counterbalance to the equity portion.

What is the tax treatment for equity-oriented balanced funds?

Equity-oriented Balanced Funds, with at least 65% of their corpus in stocks, qualify for equity fund tax treatment. Capital gains are tax-free if held for more than a year.

How are Debt-oriented balanced funds taxed?

Debt-oriented Balanced Funds are less volatile and suited for conservative investors. However, their capital gains are taxable, with short-term gains taxed at normal rates and long-term gains taxed at 20% after indexation if held for more than three years.

Are balanced funds suitable for long-term investors?

Yes, balanced funds can be suitable for long-term investors who want a diversified portfolio with a mix of growth and income while maintaining a moderate level of risk.

How do balanced funds manage market downturns?

The bond portion of balanced funds provides a cushion against market downturns by offering stability and reducing the impact of volatility on the overall portfolio.

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