Outsource your asset allocation through balanced funds

Behavioural psychologists argue that our brain can be overwhelmed when faced with complex tasks.

And when your brain is overwhelmed, logical reasoning typically fails and intuitive reasoning takes over. Now, investment decisions, especially asset allocation are, indeed, complex.

This means asset allocation for, say, your retirement portfolio may well be based on intuition than on logic. If you are young and uncertain about your asset allocation, you may well outsource the decision. In this article, we discuss balanced funds — investment products that let you outsource your asset allocation to asset management firms.

equity and bonds

A balanced fund is one that invests in equity and bonds. The proportion of investments that the fund holds in both these asset classes depends on the mandate given by the firm to the portfolio manager.

You can learn about a balanced fund’s mandate from its factsheet or offer document.

We list below some reasons why you can consider balanced funds to kick-start your investment process:

One, if you are young, a good handle for asset allocation would be a minimum of 50 per cent allocation to equity to a maximum of 75 per cent or any proportion in between.

But if you are uncertain about the asset allocation, you may well consider starting your investments with balanced funds.

By doing so, you are outsourcing your asset allocation decision to a mutual fund which may decide within its mandate, how much to hold in equity and bonds.

tax-efficient

Second, balanced funds can be tax-efficient compared to your separate investments in equity funds and bond funds. This is because income tax regulation defines an equity fund as one that holds 65 per cent or more in equity.

And long-term capital gains and dividends from equity funds are tax-exempt. This means a balanced fund that holds more than 65 per cent in equity will provide you the tax advantage even if it holds up to 35 per cent in bonds.

On the other hand, if you hold 65 per cent of your investments in equity funds and 35 per cent in bond funds separately, you will have to pay taxes on your bond investments when you redeem the units. This tax advantage is an added benefit and should not be the reason for your investments in balanced funds.

Third, if you are looking to generating higher returns from your equity and bond investments, you should switch between the two on a continual basis.

For instance, when you anticipate bond prices to go up, you should reduce your equity investments and increase your bond investments.

This process is called tactical asset allocation. When you buy a balanced fund, you outsource tactical asset allocation to investment professionals, who may be better equipped to take advantage of short-term market movements.

Suitable for young

You can consider balanced funds only if you are young. Why? For one, balanced funds typically follow active management.

That is, such funds strive to beat their benchmark index. And if your intention is to hold passive (index) equity funds and active bond funds, investing in balanced funds could increase your investment risk. For another, the asset allocation that a balanced fund offers may not be suitable to meet your investment objective. This makes balanced funds somewhat unsuitable if you are past 30, as you need an asset allocation policy to help you reach your intermediate and long-term investment objectives.

So, what should you do? If you have just started working and do not yet have a clear investment objective, start with a systematic investment plan in a balanced fund.

This will help you kick-start your investment. Continue this investment till you reach 30. It is better to ascertain your asset allocation sooner and invest accordingly than to entirely outsource that decision to a mutual fund.

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