Are Balanced Mutual Funds Still Relevant?

Balanced mutual funds were once the mainstay of many retirement investors’ portfolios.  Prestigious balanced mutual funds such as the Wellington Fund (VWELX), Wellesley Income Fund (VWINX), Dodge & Cox Balanced Fund (DODBX), and more recently the Vanguard Star Fund (VGSTX) have been helping investors reach their retirement goals for decades.

The best balanced funds, which invest in a combination of stocks and bonds (meaning they will never be on the highest-performing funds list), have been so effectively precisely because they are so boring.  Stemming from their conservative investment philosophy, the moderate losses suffered by most balanced mutual funds when the rest of the market is tanking helps prevent investors from panicking and shooting themselves in the foot by selling out of the market at the bottom.

Do Balanced Mutual Funds Still Have A Place In Your Portfolio?

Balanced funds are great, but they do have some pretty significant limitations in their traditional form.

• Difficult to fit into your asset allocation – If a balanced fund matches your desired asset allocation exactly, I suppose there’s no problem.   However, most investors will want to get more conservative as they age.  With the fixed stock/bond allocation of most balanced funds, that’s impossible without buying another fund.  And if you have to own two funds to get the allocation you want, that pretty much defeats the purpose of buying a balanced fund to begin with.
• Not tax-efficient – Bonds belong in tax-deferred accounts like a 401k or IRA.  Equities, on the other hand, can be held in taxable accounts.  With balanced funds, it’s impossible to get your asset location right.  You’re going to be tax-inefficient one way or another.  Sure, there are tax-managed balanced funds (VTMFX), but that only solves the problem if your entire portfolio is in a taxable account.  It’s just easier to invest for tax-efficiency with individual funds.
• Not truly diversified – Even the best balanced mutual funds generally hold only two asset classes: domestic stocks and domestic bonds.  Many others hold a small allocation of foreign stocks, but that’s the extent of the diversification you can expect from most balanced mutual funds.  There are no small-cap stocks, very few emerging market stocks, no commodities, and usually not any real estate.

I personally don’t own any balanced mutual funds and don’t recommend most investors own one, either.  There are a few exceptions I’ve mentioned before, such as beginners owning the STAR Fund, but I think most investors are better off putting in just a little effort and constructing a diversified portfolio on their own (here’s mine).  But buying a balanced fund and sticking to it is light-years better than chasing the latest hot performer.  To each his own.