Choosing the right balanced fund

Consider risk, income potential, geographic diversification and asset mix when you make your investment decision.

Balanced funds are a middle-of-the-road option, usually used by more conservative investors. But, as with everything else in the fund business these days, the decision-making process has become much more complicated.

When you buy units in a balanced fund, you’re getting a mixed portfolio of stocks, bonds and cash. The proportion of each depends on the mandate of the fund and/or the decisions of the manager.

Provide diversity
These funds are designed for investors who want broad diversification without the need to purchase several different funds. Novice investors or those with limited capital who can only afford to buy units in a single fund may also choose this type of security.
However, there are now several types of balanced funds available, designed for a range of investor needs. Choosing the right type is essential if you have specific objectives in mind (which you should).
A true balanced fund will usually operate within a ratio of 35 percent to 65 per cent stocks, with the balance in bonds andash.

However, some managers have a lot more leeway. Before you invest, check the parameters within which the manager must operate. That information should be in the prospectus. If it’s not, ask your financial advisor or contact the fund company directly.

If you’re a conservative investor, you may not be comfortable with a fund in which the manager is allowed to move to 100 per cent equities.

Types available
Here are the main types of balanced funds currently being sold.

Canadian balanced funds:
This is the largest category, by far. The emphasis, as you might assume, is on Canadian securities, although many funds also hold U.S. and international stocks up to the foreign content limit.

Global balanced fund:
Here the focus is on international securities, with little or no Canadian content in the mix. You will also find a few funds that limit themselves to U.S. securities or to those of a particular geographic region, such as Europe.
Tactical asset allocation funds: 
Whereas a genuine balanced fund operates within specific parameters, the manager of a tactical asset allocation (TAA) fund has much more latitude.

These are the funds that usually have the broadest parameters and there may be times when a TAA fund is 100 per cent invested in a single type of security, usually stocks. These funds are therefore somewhat riskier than a typical balanced fund, but also have greater capital gains potential.
High-income balanced funds: 
This is a relatively new category. These funds invest in securities that generate above-average income, such as royalty income trusts and real estate investment trusts.

Because much of the income is tax deferred, these funds are best suited to high tax bracket individuals, who hold them outside a registered plan. Cash flow can be very good, but risk is on the high side-some of these funds were hard hit in 1998 when oil prices plunged.
So handle with care!

Adapted from 6 Steps to $1 Million by Gordon Pape, published by Prentice Hall Canada.