There are a lot of different aspects of investing to consider if one wants to have a truly balanced portfolio. At the very least, one needs to own both stocks and bonds. Then, there are more obscure holding that might be included, such as hard assets (precious metals, real estate, or oil) and complicated securities like convertibles. It is exceedingly difficult to be good at all aspects of the process. In fact, there is a plethora of professionals that focus on just thin slices of the investing universe. This highlights how complicated investing happens to be.
That said, some investors truly enjoy the complexity and challenge of bringing a portfolio together. Other investors hate it so much that they either fail to invest for the future or completely outsource the affair to a financial intermediary. Then there is the great middle that enjoys some of the complexity, but not enough to want to take a lot of time with the process. This latter group usually comes up with some hybrid arrangement where a mix of mutual funds and stocks is sought.
This is a good path to go down, but comes with its own complexities. The biggest issue for do-it-yourself investors comes down to which mutual funds to own. This is, itself, a big task to master. Then one has to consider the percentage of one’s portfolio to allocate to each fund. At the “keep it simple” end of the spectrum, however, is the often-overlooked balanced fund, including the similar, but different, variants of asset allocation and flexible funds.
Balanced funds strive to keep a “balance” between stocks and bonds. For Value Line to consider a fund Balanced, it must have a stated policy of investing at least 25% of its assets in bonds at all times. An Asset Allocation fund uses an optimization or asset-allocation model to determine the “most-favorable” allocation among asset classes, usually in pursuit of total return. While similar to a balanced fund, the asset allocation models used usually include more than just stocks and bonds. The last option is a Flexible fund, which may invest in stocks, bonds, or cash to any degree, usually in pursuit of income or total return. This type of fund, however, isn’t necessarily guided by any models and can vary its allocations however the managers see fit.
Although these funds are generally meant to be “one and you’re done” funds, capable of covering all of one’s investing needs, they can be paired with a stock portfolio, too. To some extent, this allows investors the best of both worlds—a well-diversified portfolio with professional management and the ability to dabble to whatever degree is desired in the equity markets. Thus, an investor can own just one stock or 20 and still be diversified, spending only the amount of time he or she wants on the investment process.
That said, some funds play better with stocks then others. For example, Vanguard Balanced Index Fund (VBINX) allocates 60% of its assets to an index tracking the broad U.S. stock market and 40% of assets to an index tracking the entire U.S. bond market. Management strives to maintain that 60/40 split at all times. It would be easy to pair this fund with a stock portfolio, as one would know with great certainty how his or her additional stock holdings would affect the overall allocations of a portfolio. This fund, however, lacks material foreign exposure.
The Vanguard Life Strategy funds offer similar preset allocations and more broad exposure to the world. These would fall under the Asset Allocation grouping. Like many such offerings, these funds often use a fund of funds structure. As such, one needs to consider both the amount of leeway given to management of the fund and the managers of any underlying mutual funds.
Very often Asset Allocation funds have one or two funds that can vary their exposure to asset classes based on the manager’s perception of market conditions. While this can be seen as a good thing, as the fund will then “tilt” toward the most promising asset classes, it can also make pairing it with individual stocks a tad more complicated. Generally speaking, however, asset allocation is more art than science, so the real concern isn’t a few percentage points of shifting here or there. However, a 10-percentage point shift might warrant a closer look. This should not be viewed as a disqualifying issue, because the information should be readily available. It just increases the tracking that must be done by a slight degree.
Similar Balanced and Asset Allocation offerings can be found at Fidelity, T. Rowe Price, and through smaller fund houses or a fund supermarket. Moreover, many 401k plans offer such “all in one” funds.
Flexible funds are probably the most difficult to marry with a stock portfolio because, by their nature, they are meant to move allocations around fairly often. The idea is to give the fund manager the “flexibility” to go where the best investment options are. One day this might mean 100% stocks, the next 100% bonds. Clearly, this is not the best option if one is trying to keep track of allocations. Still, it is worth reading a Flexible fund’s prospectus if past performance, which is no guarantee of future results, has been solid. The guidelines, while “flexible” might provide enough limits that it makes sense to pair such a fund with a stock portfolio.
In the end, the idea is to simplify investing to the point where one can have fun and still hold a well-diversified portfolio that includes multiple asset classes. To this end, Balanced, Asset Allocation, and even Flexible funds can serve a valuable role. Don’t overlook these funds just because they aren’t headline grabbers.
At the time of this article's writing, the author held a position in Vanguard Balanced Index Fund.