Mutual fund investments come in various shapes and forms -- ranging from the passive index funds to the actively managed funds. Two of the most popular mutual fund types are balanced funds and dynamic funds. Let us take a deeper look at what each one is and how they are different.
Balanced funds typically invest around 65 -- 70 per cent of their corpus in equities and the remaining in invested in debt instruments. These funds are most often not actively managed, in the sense that there is less churn of the portfolio and the asset mix is more or less constant. This also means that balanced funds have lower cost structures than managed equity or debt funds, while being more expensive than passive index funds.
In terms of returns, these provide an intermediate return over pure equity and debt funds, for example over the past one year, debt funds have given around 11 per cent returns, while equity funds have generated 25-30 per cent returns -- balanced funds in the same period have given returns of around 17-20 per cent. These funds are suitable for those with a higher risk appetite, but with longer term financial goals.
In terms of taxation, since over 50 per cent is invested in equities, this is treated as an equity instrument for tax purposes, meaning that there is no capital gain if held for over a year -- enhancing the returns further. These is a good medium to long term investment option, since there will be no extraordinary returns if for example mid-cap stocks suddenly soar, but in the long run, the debt and equity will counter each other’s volatility to give moderate returns.
It is advisable to invest in these funds via the systematic investment plan (SIP) route. SIPs help to create wealth by providing the benefits of averaging, i.e. in a rising market the investor will get more returns, while in a falling market one will get more units for one’s investment; over a period of time the returns are higher. This does away with the need to time the market -- a difficult proposition even for seasoned investors.
Let us explain this with an illustration…
Assume there are two investors, Investor A who invests Rs 12,000 over 6 months in an SIP (at Rs 2,000/month), and investor B who invests Rs 12,000 lump sum. Both investors start their investments on the same date, investor A ends up with 1,118 units at the end of 6 months, while investor B has 1,091 units for the same period.
Assuming the NAV is Rs 13 at the date of redemption, Investor A makes a return of 21 per cent as compared to investor B’s return of 18 per cent.
Dynamic funds typically shift between asset classes in short time frames to take advantage of price movements in each asset class. Unlike a balanced fund which will invest in equities predominantly, and sparingly in debt -- dynamic funds have the mandate to shift investments between these asset classes. This means that when you invest the fund could be an equity oriented fund but within a month the fund could have sold all its equity positions and invested in debt instruments instead.
However, each fund house has its own rules in terms of shifting the investments -- some may be very aggressive, while others may invest the equity component in index stocks or an index fund from the same fund house. It is important to read the mutual fund document carefully to understand their investment policy before making the investment into this type of funds.
Since these funds sell equities when the market goes up, they can underperform the broader market, especially if the fund manager is very aggressive and has the mandate to shift fully to cash. However, these funds can take care of timing the market for you, since seasoned professionals do the job for you.
This is a good long term (minimum 5 year) investment option, but it is important to note that it is also a high risk investment. Do not invest for short term goals in this, but only for very long term goals -- and keep this as a portion of a larger portfolio.
Unlike balanced funds, it is important to invest in these funds in a lumpsum, since it will be difficult to time your investment to the current asset allocation of the fund, and a lumpsum investment will help you continuously realign to market fluctuations.
- Balanced funds have a mix of equity and debt
- Balanced funds offer lower returns for lower risk
- Dynamic funds shift between fully in equity and fully out of equity
- Dynamic funds are high risk -- high reward investments
- Invest via SIP for balanced funds and lumpsum for dynamic funds
Photograph: Mark Ou/Creative Commons
Anil Rego is the founder and CEO of Right Horizons, an investment advisory and wealth management firm that focuses on providing financial solutions that are specific to customer needs.