Do balanced funds make sense right now?

When stock markets turn volatile like they did earlier this year, many investors start looking for refuge — a place to put their money simply to preserve it and maybe get a modest return. Many financial advisors suggest balanced mutual funds at times like these.

Rather than take the easy way out by running to balanced funds to reduce volatility in your portfolio, we suggest a more detailed look at your financial plan and investment temperament.

In our experience, investors value liquidity and control in their portfolios most. Next come returns. And even here, most feel their concerns about losses more strongly than their hopes for gains. In other words, they want first to keep what they have and second, to make it grow. Only gamblers want instant rewards.

Balanced funds deny you control

Balanced funds give you liquidity. You can redeem and get your cash on three days’ notice. But they give you no control over your asset mix. When you need cash, you can’t decide whether to cash fixed-income securities or equities, regardless of the condition of the market.

Our approach to personal financial planning has always been the same: plan your cash needs for a minimum of five years. Then, prepare for withdrawals using fixed-income securities — bonds, mortgages, GICs and others — maturing when you need the money.

Of course, foreseeing future needs for cash may prove difficult. So keep some extra fixed-income securities or cash for emergencies or investment opportunities.

This approach lets you sell equities, or redeem stock funds, in a more thoughtful manner than simply when you need the money. You can wait for the market to offer an attractive price. And since you won’t need the cash for at least five years, you’ve got some time for the market to recover from bad times.

Create your own balanced fund

In effect, you’re creating your own balanced fund. But you retain control over the asset allocation — not in an attempt to outguess the market, but in accordance with your personal investment needs. Use fixed income for cash flow.

If you rely on balanced funds, every time you need money you’ll redeem units representing stocks and bonds combined. And when stock markets are performing poorly, that’s a bad time to redeem stocks.

As you age or approach retirement, or if your stomach for the volatility of stock markets weakens, simply lengthen your time horizon.

By that we mean prepare more than five years of future cash flow with guaranteed securities — maybe even 10 years. Gradually redeem some of your stocks and buy fixed-income securities.

How much can you take?

This approach to investing lets you keep a significant amount of your portfolio in equities, which, over time, will grow in value. And yet, you won’t need to sell any of your stocks, or equity funds for five (or 10) years. So you needn’t fret about short-term stock-market fluctuations.

Unfortunately, if you invest mainly in balanced funds, you lose the control you need to make our plan work. And you could end up, in effect, selling stocks at a poor time — like when markets take a tumble.

Another factor to consider for retirees is to how much you can reasonably take from your nest-egg each year.

If you wish to keep your capital intact, we recommend taking no more than five per cent of your total — before taxes. Many advisers these days suggest four per cent, some prefer three per cent.

Our advice comes from a realistic expectation of returns of seven per cent on your equities and three per cent on your fixed-income holdings.

If you have 60 per cent of your total in stocks and the balance in bonds, these figures will provide an overall return of 5.4 per cent.


Money Reporter, MPL Communications Inc.
133 Richmond St. W., Toronto, On, M5H 3M8, 1-800-804-8846

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