Investing 101: What is a balanced mutual fund?

If you are new to the investing game, educating yourself can seem like something akin to learning a whole new language. Before you delve into investing, however, it’s important to understand some important terms. “Balanced mutual fund” is one such term with which you should familiarize yourself before you start investing.

Essentially, mutual funds are classified in accordance to the types of investments they own. For example, some mutual funds specialize in stocks and they only own that type of investment. Those funds are called equity mutual funds. Other mutual funds only own bonds, and these funds are known collectively as fixed-income funds or bond funds. Mutual funds that own both stocks and bonds are called balanced mutual funds or, alternatively, blended funds.

There is a benefit to mutual funds if they opt to own both stocks and bonds. Basically, by owning both these mutual funds widen the pool of potential investors. They can attract investors looking to invest in bonds, those strictly interested in stocks, as well as those who want the luxury of not having to choose.

Many investors prefer to invest in funds that allow them to sink their money into a variety of things, including both stocks and bonds. Why? Because not only does this scenario likely increase the chance at a good return on investment, it also insulates the investor’s investment against major disaster should a bear market rear its head. On the downside, this investment strategy also means fewer gains in a bull market. This is because when the stock market takes a downturn, bonds hold on to their value more effectively than stocks, and when stock markets rise, bonds are typically lower yielding. Stocks and bonds offset each other in this way, creating a balance. Hence, the term “balanced fund.”

There is some risk associated with investing in a balanced fund. Namely, the expense ratio (the cost paid by the mutual fund on the behalf of its shareholders) may actually be higher than that which would be paid if you were to purchase a stock and a bond fund separately. This isn’t always the case, however. It’s just something about which investors should be aware.

Particularly for new investors who may be timid about the risks involved in some types of investing, the biggest advantage of balanced mutual funds is not really a financial advantage at all. It’s about perception. Because the risk versus reward is balanced in this type of investment, investors are less likely to panic in the face of a bear market. Similarly, when a bull market emerges, there’s no need to hold one’s breath waiting for a crash; your investments are fairly insulated. Many investors, especially green ones, would sooner choose a slightly diminished return if that return also comes without the threat of massive downturns and potential for serious loss. That’s a much less stressful concept than funds that come with the potential for big returns but also the possibility of a catastrophic drop. That is the appeal of a balanced fund.