Investors weighing merits of balanced funds

Most investors are willing to assume some degree of risk in the pursuit of better returns.

But while they will grin and bear meager results for a while, they have little or no patience with investments that actually lose money.

Based on the reality that even trustworthy large-capitalization stocks have the potential to reduce principal, balanced funds that hold a mix of both stocks and bonds are becoming the centerpieces of many individual portfolios.

"Large-cap stock funds were the anchor right up until the time stocks underperformed," said Ryan Caldwell, a portfolio manager of Waddell & Reed Advisors Asset Strategy Fund (UNASX), a balanced fund in Overland Park, Kan. "There's been a definite switch, with balanced funds finding their way into investor portfolios as a core holding around which higher-risk investments such as small-cap growth stocks are added."

Over the past five years, the annualized return of stock funds has been more than 10 percent, while bond funds delivered just under 5 percent, according to Morningstar Inc. Balanced funds provided an annualized return of a little over 7 percent for that same period.

Because balanced returns are less volatile than those of stocks and stock funds, that result is good enough for many investors.

"We have a Swiss Army knife fund, meaning you can use it any way you want to achieve your goals," said Brad Kinkelaar, co-manager in charge of the stock portion of Thornburg Investment Income Builder "A" (TIBAX), a balanced fund in Santa Fe, N.M. "Ours is a perfect fund for retirement because all retirees love to have a growing income stream, reinvesting the dividend now but knowing the income will be there if and when they need it."

Unfortunately, too many investors think a balanced fund is a balanced fund without realizing the many differences in composition.

For example, Caldwell and Kinkelaar run rather aggressive balanced funds. Waddell & Advisors Asset Strategy has 65 percent of its portfolio in stocks, 12 percent in bonds, 8 percent in gold bullion and the rest cash. The three-year annualized return is 20 percent.

Thornburg Investment Income Builder, with 80 percent in stocks and the rest in cash and bonds, has a three-year annualized return of 17 percent. Largest stock holdings include the Spanish telephone company Telefonica SA (TEF) and U.S. utility Entergy Corp. (ETR), while the largest bond holding is in Level 3 Communications Inc.