Balanced mutual funds — safe when?

May 1, 2004
If you are in or near retirement, you probably expect to invest in a mix of stocks and bonds — stocks for long-term growth, and bonds for safety and interest income to spend when needed.

Marvin Appel, PhD, and Brian Hufford, CPA

If you are in or near retirement, you probably expect to invest in a mix of stocks and bonds — stocks for long-term growth, and bonds for safety and interest income to spend when needed. But to someone unfamiliar with investments, deciding which bonds and stocks to buy and how much of each can be daunting.

Balanced mutual funds hold out the promise of relative safety and one-stop shopping. Balanced funds hold both stocks and bonds (generally in a 60 percent stocks, 40 percent bond mix). When you buy a balanced fund, you are depending on the fund manager not only to pick which stocks and bonds to buy, but also how much to bet in each market. When successful, a balanced fund can produce attractive returns at far less risk than holding only stocks. But when balanced funds stumble, the damage to your portfolio can be serious.

Why you should consider balanced funds now

That which makes balanced funds potentially interesting now — during what may prove to be an analogous period in our history — is they matched stock market returns with less risk. The last time the United States enjoyed a period of low interest rates and low inflation — like we have now — was during the early 1960s. An investor starting out in a typical balanced fund in 1962 ended up earning 6.8 percent per year over the next 20 years — the same as the return of the S&P 500 (including dividends) during the same period.

Compared to 1962, the money market appears less attractive now because Treasury bill yields are even lower than they were back then. Conversely, any corporate bond holdings in a balanced fund are potentially more attractive now than in the early 1960s because corporate bond yields are a bit higher now.

It is not surprising that the average balanced fund has lagged the S&P 500 since 1982, which has been a period of strongly rising stock prices overall. The S&P 500 gained 13.7 percent annually, while the average balanced fund gained 11.4 percent. Fidelity Puritan and Vanguard Wellington, however, very nearly kept up with stocks during the past 22 years by earning more than 13 percent per year at less than half the risk. All of these results are well above typical returns from stocks and bonds since 1926, and are far from certain to recur during the next several years.

Risk in balanced funds

During the 2000-2003 bear market, some balanced funds turned out to be good investments because losses in stocks were partially offset by significant gains in bonds due to both interest income and rising bond prices. Even so, the average balanced fund lost more than 22 percent from September 2000 to September 2002 (compared to a loss of 45 percent for the S&P 500 during the same period). Two of the better funds (Fidelity Puritan, Vanguard Wellington) lost more than 15 percent during their worst decline in the recent bear market.

Looking ahead, the risk to holding balanced funds would be a period of rising interest rates. Rising rates would potentially hurt both stocks and bonds at the same time. Balanced funds suffered from rising interest rate and bear market environments from 1969 to 1970, and from 1973 to 1974. During the latter bear market, the average balanced fund lost a third of its value. Fidelity Puritan fared a bit better by holding its losses to 25 percent.


Balanced funds are not a panacea for investment risk because they will likely suffer if interest rates rise. In a rising rate environment, money market funds would likely fare best. But if interest rates remain near current levels or rise slowly, balanced funds could be excellent investments.

Two balanced funds with good long-term track records and no sales charges (loads) are the Fidelity Puritan Fund (FPURX), and Vanguard Wellington (VWELX).

Dr. Marvin Appel is CEO of Appel Asset Management. He holds a degree in biochemical sciences from Harvard College and earned his MD in 1991. He is coauthor of Systems and Forecasts. Contact him at (516) 487-7146 or [email protected]. Brian C. Hufford, CPA, CFP, is president of Hufford Investment Advisory Programs, LLC, and Hufford Financial Advisors, companies dedicated solely to helping dentists secure solid financial planning and safe investment strategies. He can be reached at (317) 848-4987.

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