Posts Tagged ‘balanced funds’

The markets are down, making mutual funds all that much more important for risk averse investors. That is not to say stocks do not have their place, but the reason I love mutual funds so much is because they offer so much diversification (some would argue over-diversification) that risk becomes somewhat limited. So what does that mean for a mutual fund investor? It means greater participation in specialty funds like gold funds, small cap funds, BRIC funds, and so on. What this ultimately means for your every day investor is:

• yes, the markets will tank and bring down their investments. But when core investments drop, other investments hold down the fort. Which investments will it be? Bond funds? High Yield Investments? Small Cap funds? If I or anyone else could predict such things ahead of time, we would never both with those core holdings in the first place, would we? By being properly invested, the risk of being wrong is reduced or eliminated… something’s gotta win.
• opportunities to rebalance. Maintaining a proper asset mix is essential to long-term success (compared to chasing the winners every time a winner is identified). This means that as markets increase or decrease, the asset mix will shift. This calls for rebalancing, trimming those assets that have done well and dumping money into smart mutual funds that have not fared so well. This achieves two things: it reduces over-exposure and it allows to buy assets when they are considered “lower.”
• buy more when markets suck, buy less when they are heroic. This is the basis of dollar cost averaging, something we should probably stress more often at this site. Still, when markets tank, it reminds us of the importance of never throwing all of our money on the table at once. It reminds us to ease into a position(s) gradually.

Now what does this all mean to how I would invest 10,000? It means that if I was given $10,000 today and told that I had to invest it (instead of spending it on a bunch of toys for the summer), I would:

1. Determine my asset allocation model. You can do that right on this site if you want, or you can ask your advisor to help you figure it out for you. Mine will show: 60% Equities and 40% Income (this is after I decided to ignore the cash recommendation and invest instead in fixed income). Seems conservative unless I am a balanced investor, yes. But let’s take a closer look…
2. Research the following mutual funds; a good Balanced Fund like the PIMCO All Asset fund, which is a medium risk, high return 4-star rated fund. I would throw $7,500 at this fund because it is not only well managed, but the underlying assets are those that I actually believe in. And then I would invest in the Ivy Small Cap fund (a fund I have been laughed at for picking and sticking to, but one that maintains all of the fundamentals that I personally believe in and trust). This fund will allow me to invest $1,500 of the remaining $2,500, leaving me with $1,000 which I would throw at the Franklin MicroCap Value fund, another 4-star fund but one that has virtually no risk associated with it and a track record that would make old pros blush.
3. Review, review, review. Yes, three times.  Per month, that is. Because I think these assets are placed so well, the portfolio would fall out of balance fairly quickly.

If permitted, I would add a 4th point: split the $10,000 into ten $1,000 contributions. This would not be possible in the case of the funds I chose here, but if I had, say, $40,000 to invest, I would invest 10K now, the remaining $30K over the next 2 years. And all of it would be in mutual funds; small cap funds and a balanced fund, maintaining as close to a 60/40 split as I possible can given that balanced funds will not report in real-time what their holdings are.

Education savings plans have increased in popularity over the past decade or so. As people have struggled with savings for their children’s education, so too have they struggled with where to invest the money they set aside every week, month or year. But interestingly, they struggle less when it comes to the mutual funds that are part of an education savings program than they do with their own savings and their retirement savings in particular. Since most people will start with smaller numbers when saving for a child’s education, the natural start is with mutual funds; balanced funds in particular.

It is not so much about knowing where to invest than it is about how to invest.

And this makes sense. Balanced funds offer tremendous growth opportunities in the mid- and long-terms. A balanced fund that takes a tactical approach to investment management will do its best to get a lead on the markets, whether it is in bonds or equities or a tactical approach to both. Ideally, however, tactically managed balance funds will provide active investment management, something that many people cannot enjoy with investment values of $100 per month.

More importantly however is that people who decide on balanced funds are more inclined to “sit” on them during periods where market values erode, such as what was seen up until 2009. This becomes a strategic approach, then, so that it is not so much about where to invest than it is about how to invest.

Unfortunately, many investors who witness the type of portfolio erosion that most investors witnessed from the end of 2007 through to the first quarter of 2009 get nervous. They hate to see the type of devaluation that they undoubtedly witnessed. And where their education savings are concerned, the time horizon for that investment may not be as long-term as, say, their retirement savings; Junior will be going to college in two years and cannot wait the fifteen years that I can wait to see that education savings plan recover.

So they pull the plug. They drop that terribly depreciated balanced fund and decide against all wisdom, all historical evidence and advice that where to invest is actually in income-producing securities. Not high yield investments, either because all companies are going the way of GM, Ford and Chrysler or because they have become turned off anything corporate altogether. So instead of those high yield investments, they choose government bonds or, worse yet, term deposits.

And we all know where those rates are. They are low, they provide so little income that the purchasing power erosion combined with rising tuition costs will have a negative compounding effect on the actual purchasing power of the original investment. In addition, as those government rates start to rise to compensate for inflationary pressures, the value of those bonds will decrease (of course, TD’s will retain their par value, but at virtually 0% interest, they provide next to no liquidity… there is no getting out until the maturity date).

So where is the true logic in bailing at what could be ultimate low in that balanced fund’s market value?

That’s the thing, there is no logic. Emotions overtake logic.

This past year has illustrated that history has a way of repeating itself. And of course, those who bailed at the ultimate low have seen that markets do recover.

Statistically, people who invest in education savings are more apt to sit tight. And this is a good thing, as history has proven time and again.

In regards to knowing where to invest in an education savings program, realize that Balanced funds clearly provide the best overall option, particularly for people with lower dollar figures to invest (which would probably be most people). Not only do many balanced funds provide enough of a tactical investment management approach, allowing the fund managers to shift from one asset class to another in times of market turmoil, but they are normally managed by the best and brightest — and most of us are nowhere near as intuitive as they when it comes to investing.

And for those with larger amounts to invest. Consider a strategic asset allocation model.

Because knowing where to invest is often secondary to knowing how to invest.

There are times when, as an individual investor, I have to shake my head at some of the bonehead positions that even the world’s best mutual fund managers take. Whether it is an equity fund, a bond fund or balanced fund, evne those people who are known as the world’s “greatest” mutual fund managers make trade decisions that would make even the world’s “most novice” investor look like Warren Buffett.

But here’s the thing. Bond funds demand full (or close to full) investment in income-producing securities. A Bond Fund manager cannot sit on the sidelines and not take a position. The same goes for the biggest growth funds (and perhaps it is more-true for these growth fund managers than any other type of mutual fund manager) because sitting on the sidelines often means missing out on growth… even in times of economic uncertainty.

Tactical In Nature

This leads us to the topic of this post: Balanced Mutual Funds. As a balanced fund junkie, I am always amazed at how many different configurations these balanced mutual funds take. Unlike other funds, balanced funds are almost always tactical in nature. Their ever churning asset allocation reminds me of the ocean waves. When the tide comes in, so do the returns. Then they dump their overbought holdings and move into something with greater opportunity, whether that is income in nature or something else with a great P/E ratio or some other promising technical or fundamental indicator. Rinse and repeat (Note: Hedge funds will actually take aggressive short positions, something mutual funds will not do).

Dynamic Response To Market Events

Balanced mutual funds admittedly have one advantage over straight growth and bond funds; they can respond dynamically to market events. This means that periods of high interest rates allow balanced fund managers to dump low-dividend yield stock and get in deep with bonds that they feel will increase in value as rates drop and will consequently provide higher regular income over the duration of their holdings. Hussman’s Strategic Total Return fund is a fine example of how some balanced funds can defy gravity… and with just 31 holdings (as of January 19, 2010) it just comes to prove my next pont!

In fact, the way balanced funds can respond to markets is such an exciting benefit that balanced funds have over other classes of mutual funds that it makes one wonder why everyone does not have a least 25% of their portfolio invested in balanced funds.

Top Level Management… At Cheap Prices

In the case of the Hussman fund noted above, you will pay just 0.75% according to the Prospectus to employ John Hussman as the manager of your investment. And your minimum investment in this case is just $1,000. Of course, Hussman is just an example. Most fund companies empower only their best and brightest (or teams of the best and brightest) to manage their balanced funds, and all at rates comparable to those seen at Hussman (many are even cheaper). Last I checked, it costs more to refinance a mortgage and let the bank make some real money.

As evidenced here, there are some great benefits to investing in balanced funds. In no way is this list even complete. In fact, it deals exclusively with tactical balanced funds… and these days, there has been a growing interest and investments in these strategic funds, many of which offer specific “target dates.” Well, that’s food for thought on another day because those balanced funds are equally attractive.

Investment management is one of those things that crosses many investment territories, from a basic term deposit laddering strategy to a more complicated mutual fund investment strategy to complex, corporate strategies involving bought deals, derivatives and other exotic investment vehicles. But ultimately, investment management can be broken down into two simple camps:

1. Strategic Investment Management
2. Tactical Investment Management

These two approaches are recommended for individual investors as well. Choose one and follow it.

Investment management boils down to either Strategic or Tactical Investment Management.

Strategic Investment Management

The strategic school of investment management involves making a decision at the beginning of the investment journal and sticking to it. For example, an investment manager might choose an investment strategy that involves earning fixed income through interest and dividends for 1/2 of the portfolio and actual capital growth for the other 1/2. That means that, all things being equal, 1/2 of the portfolio will be made up of income-generating investments and the other 1/2 will be made up growth investments.

In other words, the strategy calls for a 50/50 split between income and equities. As equities grow more than income, part of the equity class will be trimmed back so that there is no over-exposure to equities and the strategy remains intact.

Problems arise with this strategy throughout the investment process. At the start, it is often difficult to decide on the strategy in the first place. Throughout the program, the investor often has a tough time keeping to the strategy, trimming where needed (it is tough to sell off assets that are performing well), and again throughout the program it is difficult to adjust the strategy to meet changing life circumstances (such as raises at work, increasing net worth, upcoming retirement, and so forth).

However, strategic investing is also considerably simpler as it does not involve continuous evaluation of the underlying investments. You decide on the strategic asset allocation and stick to it. It’s that simple.

Tactical Investment Management

This school of investment management forces the investor to make ongoing investment and investment class decisions. Since our site is dedicated to Mutual Funds, we will look at tactical mutual funds. In its simplest form, the tactical school will mostly consist of Balanced Funds that are allowed to shift from one extreme to another. For example, a tactical balanced fund might hold 90% equities one month and then shift their portfolio to consist of 90% bonds in the following month.

Tactical investment management involves consistent portfolio and asset management. Additionally, it involves reading, evaluating and calculating the market, economy, and individual market sectors. For example, Tactical asset managers might decide on fundamental portfolio changes based on an industry sector publication. A real-life illustration might start with a manager reading a manufacturing report that suggests higher raw steel sales. This report might lead the manager to a business article that interviews a 2nd Tier automotive manufacturer who might comment on his company’s inability to obtain raw steel to meet customer demands thanks to large orders in the farming sector. As the trail progresses, the manager might find that instead of holding automotive-company bonds, he or she should actually be buying Caterpillar and John Deere stock.

Problems with the tactical investment model is that it relies heavily on research and decisions made by the management team. If that management makes the wrong call, it could result in devastating losses for the fund and, ultimately, the investor.

Conclusion

Understanding the two different schools of investment management allows the individual investor a bit of an edge when coming up with his or her own investment strategy. Even with a mutual fund investment, some strategies will involve regular review and monitoring, rebalancing and research. These investment management schools are not exclusive to mutual funds, but to all investment types and to all levels of investor, whether individual or corporate.

If you have the problem of not knowing where to invest $10,000, you have a problem that many people would love to have. But not knowing where to invest is not the true problem; it is a symptom of the problem of not knowing enough about investments and the optimal investment vehicles. While some people might understand the basics of mutual funds (they are pools of funds where hundreds, thousands, or even hundreds of thousand of investors write checks to these fund companies, who then take all of this collective money and purchase securities on the open markets and then return the gains, proportionately, to the people who invested in the funds), fewer yet understand the different asset classes — Equity, Income, and Cash/Cash Equivalents — and even fewer understand how the different funds operate in terms of investment management strategies.

Not knowing where to invest $10,000 is a great problem to have… but that is not the problem. The problem is investment knowledge.

The easiest way to understand investment management is by understanding how the following chart below works. Ultimately, there are three areas; red, blue, and yellow.

Asset Allocation Model

This chart illustrates the basis of asset allocation. Each color represents an asset class; equities, income and cash. Understanding your risk tolerance, investment objectives and time horizon will allow you to allocate part of your $10,000 to specific areas at specific, pre-determined ratios.

For example, if you have a medium risk tolerance with an investment objective of income and some growth, with a time horizon of five years, then you might consider an asset allocation model as follows: 25% Equities, 65% Fixed Income, and 10% Cash. In this chart, the Equities would be the Blue portion, Fixed Income would be Red, and Cash would be yellow.

The fundamentals of a strategic investment management suggest that all you need to do now is ensure that these assets stay within their limits (65% Income, 25% Equities, and 10% Cash) through period rebalancing.

So, where does that leave you when it comes time to invest $10,000? Depending on your level of investment knowledge and how well you know your stuff or how much you trust your financial advisor, then you could easily develop your own plan using a well-defined asset allocation model.

If you would rather not have much involvement with your investments, then you are probably best served by a Balanced Fund. This is a common choice for people who need a place to invest $10,000 and they need a little more time to educate themselves on the different investment options they have.

Why Balanced Funds? These types of mutual funds offer active investment management from top investment managers at a reasonable price. Most of these managers would not normally deal with people with less than $1,000,000 in investments… yet here you can access them with 1/100 of that amount.

Balanced Mutual Funds offer active management from investment industry leaders.

So where does that leave the average invest with his or her $10,000? Starting with a Balanced Fund that aligns with his or her investment objectives, risk tolerance and time horizon is ideal. While the fund operates on its own, the investor will be able to learn more about other investment options, if the desire is there. Of course, many investors will remain invested in Balanced Funds. In fact, many private bankers will use their institution’s balanced fund portfolio managers to manage their high-net worth clients’ funds. The only difference is that private bankers will deal with people who have extremely high net worth; balanced mutual funds will help people invest $10,000.

Ultimately, the question about where to invest $10,000 can be answered introspectively. If you have high investment knowledge, then mutual funds are probably not your ideal investment. If, however, you have moderate to no investment knowledge (like most people), then mutual funds work well. If you feel you need to learn more before making a permanent investment decision, then balanced mutual funds are the best place to invest $10,000 after all.

Insofar as mutual funds are concerned, balanced funds are those all-encompassing funds that can meet an array of investment management requirements. In many cases, people who are new to investments and want to know where to invest with the least amount of risk while still enjoying an accurately built asset allocation model will start out of with balanced funds.

The reason for this is simple. Most of the balanced funds available to investors will invest in all three asset classes (cash, income and equity). Actively managed balanced funds will modulate their asset allocation in an attempt to take advantage of market pressures one way or another. This mostly means increasing income-class investments while simultaneously reducing equity class investments when equity markets are considered overbought (hot) and vice versa when equity markets are oversold (underpriced).

If we call the above types of balanced funds tactically managed funds, then we can consider another type of balanced fund where the asset allocation is already determined and the fund’s mandate is to stay the course with its asset allocation design. For example, consider a fund that promises a steady 25/75 income to equity ratio. This type of balanced fund will rebalance its asset each time the weighting exceeds a predetermined deviation from the original ratio. For example, if equities are strong and grow more than the income portfolio so that the weighting is 20/80, equities would be sold off and income investments purchased with those gains so that the weighting returns to 25/75.

In both instances, these balanced funds exist to achieve different results, therefore they exist for different investors.

Ideally, the investor who is just starting or learning to invest might prefer actively managed balanced funds where asset allocation can swing freely from one extreme to another at the discretion of the fund manager. This allows the investor to enjoy a professionally managed portfolio with little up-front investment (many of these professional fund managers would deal only with institutional investors otherwise, or people with well over $1 million in investible assets, so to take advantage of their expertise is really a treat for the novice investor).

Investors who have built a larger portfolio will begin to understand the value of sticking to a particular asset allocation model and may therefore prefer to adhere to their specific model. This means a fixed asset allocation fund will make more sense for this type of investor. That does not mean that this type of investor will need to abandon actively managed balanced funds in favor of this type of investment. However, as asset size grows, so must the attention to details insofar as the portfolio is concerned. As such, it is normally recommended that investors who have accumulated wealth under an actively managed balance fund will be urged to minimize their risk by investing in other asset classes or other investments so that there is no over-exposure to a single fund.

Ultimately, balanced funds are ideal starting points for beginning investors or people looking to enjoy the benefits of active asset management at a fraction of the cost. Likewise, strategic balanced funds where the asset allocation is strictly adhered to also make sense when investors accumulate a relatively substantial amount of wealth and wish to protect against management exposure.