Balanced Funds Still Make Sense for Long Haul

This has been a big year for equities, and balanced mutual funds haven’t made much noise lately. If these investments seem to be a bit out of favor, there are several good reasons why:

* Balanced funds, so named because they hold mixtures of both stocks and bonds, have lagged pure-equity portfolios in 1995. On average, balanced funds have about 35% of their assets invested in bonds, which haven’t fared nearly as well as stocks this year.

* Balanced funds also underperformed in 1994, sustaining an average loss of 2.5%. Again, bonds were primarily to blame, as the bond market slogged through one of its worst years ever.

* Asset-allocation funds, some of which pursue sexier investment approaches, have stolen some marketing thunder from their staid balanced-fund cousins, several of which date back to the 1920s and 1930s. Asset-allocation funds are more likely to hold small stocks, foreign stocks or gold shares, or to pursue novel approaches such as life-cycle investing.

“With asset-allocation funds, you have a wider range of choices,” says Steve Norwitz, vice president at T. Rowe Price Associates, a Baltimore firm that offers both types of funds.

But it’s premature to count balanced funds out. The idea behind them remains a solid one for the long haul, and few competing categories make as much sense for investors who can afford to buy just one or two funds.

The rationale for balanced funds rests on the notion that the stock and bond markets tend to move somewhat independently. In particular, stocks and bonds rarely go down in lock-step.

In the years since the mid-1920s, for example, blue-chip stocks and government bonds both have lost ground in just five of those years, according to researcher Ibbotson Associates of Chicago. Blue-chip stocks and corporate bonds have stumbled together just four times.

The stock holdings of balanced funds can be counted on to generate higher returns over time, and the bonds help pave a smoother ride. Balanced funds are a third less volatile than growth-stock portfolios, Morningstar Mutual Funds of Chicago reports.

*

But balanced portfolios certainly aren’t risk-free, and they do vary in terms of approach. Investors thus should know what to look for to ensure they don’t buy an inappropriate product. One red flag would be a balanced funds that makes big bets on particular industry groups. The CGM Mutual Fund of Boston got into trouble in 1994 by doing just that. It fell 9.7% for the year.

“Portfolio manager Ken Heebner has a nasty habit of making big bets in investment areas that don’t work out,” writes Jay Schabacker, a Potomac, Md., investment adviser and newsletter editor who recently tabbed CGM Mutual as a fund for investors to consider selling.

That might be an exaggeration, given CGM Mutual’s record as the top balanced fund of the past decade. But Schabacker’s point remains: Risk-shy investors can’t assume that every balanced fund will offer a smooth ride.

Another caveat involves balanced funds that stock up on foreign investments. Fidelity Balanced, another fund that Schabacker dislikes, has been holding 20% to 25% of its assets overseas. Few people would dispute that foreign stocks and bonds have a place in a well-diversified portfolio, but most investors expect to find them in global or international funds, not in balanced products.

And balanced funds vary quite a bit by the types of bonds they hold. One shortcoming of most such funds is that they own taxable corporate and government bonds rather than tax-free municipals. This may encourage some investors to make their own balanced portfolios by combining a stock fund or two with a muni-bond fund.

USAA Investment Balanced in San Antonio, Tex., is one of the few funds of its class to stick with tax-free munis on the bond side. The Vanguard Group in Valley Forge, Pa., recently unveiled a fund with a similar bent, called Vanguard Tax-Managed Balanced.

*

Perhaps the biggest factor working against balanced funds these days is the huge number of mutual funds available--about 6,000 separate portfolios.

With such a wide choice, many investors are no doubt tempted to build their own balanced portfolios using separate funds as ingredients.

Yet for people who can only afford just one or two funds, or for those who want a solid core investment, balanced funds still make sense.

“Balanced funds have been around so long that most people take them for granted,” Norwitz says. “But they’re still a pretty good way to go.”