What are Balanced Mutual Funds & How They Work?

1. Rebalancing of Funds

There may be instances wherein the equity market is overvalued compared to the debt market and vice versa. In such circumstances, a fund manager can navigate the two asset classes – debt and equity. As a result, he/she effectively balances the fund’s performance and tackles market fluctuations.

2. Lowers Risk

Equity markets are highly volatile. Therefore, investments in pure equity funds involve significant risk. In this regard, the debt component of a balanced fund allows one to balance out the associated risk of investment posed by its equity component.

3. Diversifies Investment Portfolio

Balanced mutual fund investment is an ideal vehicle to attain portfolio diversification. Moreover, this diversification ensures the dual benefit of risk reduction as well as capital appreciation.

4. Protection from Inflation

Given their unique allocation of assets, the equity component of balanced funds offer higher returns while their debt portion extends regular income. As a result, these mutual funds serve as a hedge against inflation.

5. Tax Implications

Capital gains on balanced funds are taxed depending on the equity-debt orientation of a fund in this manner:

• Equity-Based Balanced Funds: These funds are taxed like pure equity funds. So, long-term capital gains (LTCG) earned on the sale of mutual fund units after a holding period of 1 year are tax-free up to ₹1 lakh. LTCG exceeding ₹1 lakh is taxed at 12.5%, excluding the indexation benefit. On the other hand, short-term capital gains, which are earned on the redemption of units before a holding period of 1 year, are taxed at a rate of 20%.
• Debt-Based Balanced Funds: These mutual funds are taxed like debt funds. Therefore, in the case of investments held for less than 3 years, STCG is taxed according to one’s applicable tax slab. LTCG earned on redeeming units after 3 years is taxed at 20%, along with indexation benefits.

1. Expense Ratio

Like any other mutual fund, hybrid or balanced funds levy an expense ratio. Expressed in percentage, the expense ratio is the fee charged by an asset management company for its services. Naturally, a high expense ratio increases the cost of investment.

2. Past Performance

Prospective investors must evaluate the past performance of a balanced fund before investing in it. That said, one must note here that although it is an important factor, past performance is not an indicator of future returns. Therefore, it is wise to take a fund’s past performance into account to have a rough idea of its probable returns.

3. Risk

Balanced funds are considered to be less risky than other mutual funds, like equity funds. However, as investors may already know, all mutual fund investments involve some risk. Therefore, investors must gauge their tolerance for risk before investing.

4. Experience of the Fund Manager

It takes years for one to learn the effective navigation of funds through market fluctuations. So, a fund manager with several years of experience in the industry will have the necessary knowledge and know-how to tackle market volatility and maximize returns.