Beginners: Learn All About Balanced Mutual Funds In 5 Minutes

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What is a balanced mutual fund?

Balanced mutual funds are also known as equity oriented hybrid funds, these funds are a combination of equity as well as debt. The name of the fund is a little misleading, as the word ‘balanced’ gives an impression as if the asset allocation would be 50:50 towards equity and debt but in reality the equity portion is pre-dominant in a balanced fund. The equity portion varies from 65%-80% whereas the debt portion varies from 20%-35%. These funds provide capital appreciation with equity and safety through debt. Average return from such funds have been between 12%-15% for last 10 years.

Is a balanced fund suitable for me?

Generally, a balanced fund is suitable for investors who have investment horizon of at least 3 years with a moderate risk appetite. Someone, who has a investment horizon longer than 7 years with same risk appetite or someone with a high risk appetite shall prefer equity fund over a balanced fund.  It shall also be noted that balanced funds might not be suitable for someone with low risk appetite, this is because equity portion, which is considered highly risky, is pre-dominant in a balanced fund. Someone who has a low risk appetite or a investment horizon shorter than 3 years, shall prefer a mutual fund where equity portion is 50% or lower.

What is the tax treatment of returns from a balanced fund?

Capital Appreciation

Since, balanced funds have equity portion greater than 65%, so they are considered at party with equity funds and hence they are eligible for exemption from long term capital gain tax if held for more than one year. Where, mutual fund units are held for a period shorter than one year, the short term capital gain is taxable at 15%.

Dividend Income

Dividend income is completely exempt irrespective of the period of holding.

Balanced Funds vs Investing in Equity Funds and Debt Funds separately

Some investors try to replicate the balanced mutual funds by investing their 65% capital in one equity mutual fund and 35% capital in a separate debt mutual fund. However, it is not advisable to do so because of the following reasons:
  1. Missing the benefit of exemption from long term capital gain tax on debt fund

    The 35% capital invested separately in debt fund will not be eligible for exemption from long term capital gain tax and hence 20% tax would be payable after indexation if held for 3 years or more. However, complete exemption from long term capital gain tax would be allowed on whole investment in a balanced mutual fund if held for a period of just 1 year or more.

  2. Missing the safety cushion of portfolio re-balancing

    Generally on account of higher capital appreciation from equity portion as compared to debt portion in a balanced fund, the overall asset allocation gets more inclined towards equity. Balanced fund managers aim to maintain equity and debt allocations within certain target ranges. If the allocation towards equity exceed the target range then fund managers rebalance their asset allocation to bring it back within the target range. If stock prices run up substantially, then fund managers will book profits in stocks and re-invest in debt. When stock prices fall substantially, fund managers will invest in equity to bring asset allocations back within target ranges. Asset rebalancing results in greater returns stability for balanced funds compared to riskier asset categories like equity mutual funds.

Balanced funds are targeted at customers with moderate risk appetite. Make sure that the equity portion of the portfolio does not have too high an exposure to mid-cap stocks and the debt portion does not carry too much duration risk. Check past performance and make sure that the fund has consistently beaten its benchmark (usually the Crisil Balanced Fund Index). Click here to read more about how to select the best mutual fund.

Author:

Sahil Goel | LinkedIn