The case against balanced funds

Though balanced funds are extremely popular with Canadian investors, we see little appeal in these investment products. It’s better to create your own balanced fund by selecting stock funds and fixed-income products according to your own needs.

Balanced_FundsWe include one balanced fund in our Recommended Mutual Funds list. But we recommend you buy it only if you would rather not do the work it takes to set up a portfolio of securities that’s more suitable for you.

Balanced funds, of course, are extremely popular with Canadian investors. After all, they command over 50 per cent of all assets Canadians hold in mutual funds. That’s up considerably from about 15 per cent more than a decade ago.

But we see little reason to be part of the crowd. A better solution is available for any investor willing to put in some time.

Control your own asset allocation

You’ll likely save money and enhance your control over your asset allocation by effectively creating your own balanced fund. All you need do is invest in some stock funds and some bond funds. Indeed, most fund companies offer stock funds similar to the stock portion of their balanced funds. And the same goes for bond funds with respect to the bond portion of their balanced funds.

What’s more, because of the nature of the bond market, you can invest in ultra low-cost bond funds and significantly reduce your overall management expense ratio.

Exchange-traded bond funds offer you bond exposure with minimal cost. And with some of these products, you can feel confident you’ll know exactly what will be in them at any given time, such as those that ladder their maturities over a one- to five-year period.

Managed bond funds, on the other hand, are generally too expensive. And that’s especially true with interest rates still low.

The real bonus from creating your own balanced fund, however, lies in the added control it affords you. By holding your investment in these two asset classes—equities and fixed income—separately, you can adjust your asset mix yourself.

If you’d like to add some equity exposure at a time when prices are down and risk has been reduced, simply add to your stock funds. If, on the other hand, you’d like to raise some cash by reducing your exposure to equities, you can.

You simply don’t have this kind of control when you hold balanced funds.

You can, of course, increase your control further by owning fixed-income securities (bonds, stripped coupons, mortgages, GICs, etc.) directly. That way, you can invest in securities that mature when you need the cash. That’s something you generally can’t do with bond ETFs or managed bond funds.

Heed those sales charges

Whether you decide to invest in a balanced fund, or do your own asset allocation through picking stock and bond funds, keep in mind that management expenses are not the only fees that will affect your results over time. Nine of the sixteen funds on our recommended list charge front-end and/or back-end fees. If you pay the five per cent front-end load commonly specified with such funds, you can multiply your final performance by 0.95.

So if you invest $10,000 in a no-load fund, and it increases in value by 10 per cent after management expenses are accounted for, your final result is $11,000. If, however, you pay a five per cent front-end load, multiply $11,000 by 0.95 and your final result is $10,450.

Any time you choose a fund with a front-end load, always check the prospectus for a service fee. If it’s there, and it usually is, then negotiate especially vigorously for a reduced commission. Aim for no more than two per cent of your investment. After all, the agent still has plenty of incentive to get your business.

If there’s a choice between front-end and deferred charges, make sure the deferred-load alternative doesn’t entail an increased annual management fee. Over years, that can more than offset a small front-end load.

This is an edited version of an article that was originally published for subscribers in the May 18, 2018, issue of Money Reporter. You can profit from the award-winning advice subscribers receive regularly in Money Reporter.

Money Reporter, MPL Communications Inc.
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