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Balanced Funds: What Are They? Advantages, Taxes & More

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Balanced Funds: What Are They? Advantages, Taxes & More

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What's your risk appetite? Are you someone who likes to take high risk or someone with a conservative attitude towards riskier investments? Or are you the third kind, where you like some amount of risk but don't want to lose too much? If you're the third kind, a balanced fund is perfect for you. 

What Is A Balanced Fund?

A balanced fund is a hybrid fund that is usually open-ended and invests in equity as well as debt instruments. SEBI rules mandate that balanced funds invest 40-60% of their assets in equity and the other 40-60% in debt securities. Arbitrage is not permitted.

The primary aim of balanced funds is to give investors some stability, or as the name suggests, a balance between capital appreciation and risks.

These investment funds diversify their holdings between two or more asset classes. They are also called asset allocation funds. Balanced funds, in contrast to life-cycle funds, don't change their asset mix. They also differ from actively managed funds which pivot their asset mix in accordance with broader market conditions or other factors.

What Can You Expect From A Balanced Fund Portfolio?

If you have a low risk threshold, you can invest in balanced funds for extra income. This also makes balanced funds ideal for the elderly and retired. They're a mix of bonds and stocks. Let's get into more details. 

Equity

Balanced funds ordinarily invest in large equities such as those listed on prominent stock indices. These funds may also buy stocks of companies that issue dividends. Dividends are the cash payments companies give their shareholders as a reward for buying (and holding) their stock. 

Bonds

With bonds, you have the option of making some extra income. Bonds help reduce your fund portfolio's volatility that results from fluctuating equity prices. It isn't unusual for investment-grade bonds to provide interest income twice a year. Large company stocks may provide dividend payouts each quarter. 

For retirees, cash can help boost their pension, government subsidies as well as personal savings.

Although highly graded bonds are traded daily, they ordinarily don't experience major price swings faced by equities. Consequently, major leaps in a balanced mutual fund's share price are prevented because of the stability that fixed-interest securities provide.  

An interesting note here is that the prices of debt securities aren't always aligned with stocks, and their trajectory can be against them. Bond stability helps smoothen the investment return a portfolio draws over time. 

What Do Balanced Funds Have Going In Their Favour?

1. Affordable

Since balanced funds rarely need to change their stock and bond holdings, they generally have lower expense ratios. In other words, they're mostly more affordable compared to other types of mutual funds.

2. Low Risk 

As these funds diversify their capital across several different stocks, the market risks are limited in case certain sectors or stocks don't perform as expected.  

3. Easy Withdrawals

Balanced funds let you withdraw money on a regular basis without ruining their asset allocation.

Disadvantages Of Balanced Funds

1. Fixed Asset Allocations

Since a balanced fund must control its asset allocation rather than its investors, this allocation may not align with investors' tax-planning strategies. This means that these funds aren't the best option for tax-shielding strategies.

2. Less Than Ideal Asset Allocation

Balanced funds ordinarily allocate 60% of their capital towards equities and the remainder to bonds. This might not always align with the financial needs of investors, whose goals and preferences may change with time. 

Safe But Limited Returns

Certain balanced funds can proceed with extreme caution resulting in them not venturing towards international or offbeat markets. This can end up blocking potential returns. 

Taxation On Balanced Mutual Funds

Since equity-oriented balanced funds have at least 60% of their corpus directed towards stocks, they are treated as equity funds for tax purposes. This means that capital gains drawn are tax-free, provided these investments are held for more than a year. These funds are subject to more volatility owing to a greater stock allocation.

In contrast, debt-oriented balance funds aren't as volatile and are best suited to those with a low-risk threshold. That said, they provide far more modest returns and the gains drawn aren't entitled to tax exemptions. In case these investments are held for under three years, capital gains drawn from them are treated as short-term, and normal rates apply. 

If investment holdings exceed a 3-year holding period, capital gains are viewed as long-term and have a 20% taxation rate applicable after an indexation benefit has been applied. This can reduce the applicable tax considerably.

Summing up

Balanced funds are ideal for investors who want some amount of equity exposure in addition to debt. This is especially true if you want the benefits of high-risk equity investments. It is crucial how you choose to invest your money such that you don't expose yourself to more risks than you can afford to take on. On Fi Money, you have zero-commission mutual funds that you can browse, filter and choose. 

Frequently Asked Questions

1. Are balanced funds good investments?

Balanced funds are good investments for those who are new to equity investments as they invest in stocks while keeping risks minimal. 

2. What are the returns of a balanced fund?

The top balanced mutual fund of 2022 has given over 25% returns per year, with the next highest around 20%.

3. Are balanced funds high-risk?

Balanced funds are not considered high-risk. As the name suggests, they balance the risk associated with equity against that of debt assets.

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