Balanced Mutual Fund: An overview

Mutual funds are traditionally classified by the investment asset class they own. Mutual funds which own only stocks (Equity) are called Equity mutual fund. Mutual funds which own only bonds are called bond fund. Mutual funds which own both bonds and stocks are called hybrid fund.

Balanced Mutual fund is a hybrid Mutual fund which invests in both equity and bond. Typical Balanced fund invests 65% in stocks and 35% in bond.

Benefits of investing in Balanced Fund:

•     Balanced fund provides twin benefit of growth (from equity component) and stability (from debt component)
•   Balanced fund offers automatic re balancing- Assume equity is growing faster than the bond then weight of equity crosses 65%(prescribed limit); then fund manager would book profit from equity and invest the same in bond
•  Balanced fund offers lower volatility compared to an equity funds
•  Balance fund offers better liquidity and more tax efficient than the bond funds

Potential return and tax effect:

•  Balanced fund over last 5 years have generated a CAGR return of 15-16%; the realistic long term expectation going forward could be close to 12%.
•  Balanced fund are treated as equity fund from tax perspective. Short term capital gain tax of 15% is applicable if redeemed (withdrawn) within 1 year and long term capital gain tax of 0% is applicable  if redeemed (withdrawn) after 1 year

Potential risk

• Balanced fund invests 65% in equities which is subjected to market volatility and hence the fund return would be more volatile compared to a bond fund/bank FD

Conclusion: Balanced fund offers automatic re balancing which allows your investment portfolio to be more balanced in different market conditions.  Balance fund offers good return, provides diversification benefit, offers flexibility and are tax efficient (long term capital gain is zero percent).Balanced fund comes handy in portfolio building and is a good option for first time equity investors.

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Bank FD vs Bond Mutual Fund: Taxation

Bank FD & Bond Fund both are fixed income securities. The most ignored part while investing in fixed income securities is the effect of taxation. The blog highlights the differences

Tax Effect on Bank FD

Taxes are paid on accrued interest and payable as per the individual tax brackets.

Ex Mr X invest Rs 10 Lac in a bank FD yielding an interest rate of 6%; Mr X is in a 30% tax bracket; then Mr X has to pay an average tax of Rs 18,000/Annum. The effect of tax over 5 year is as shown below

	Year 1	Year 2	Year 3	Year 4	Year 5	Total
Interest Income	60,000	60,000	60,000	60,000	60,000	3,00,000
Tax Effect	Income	Income	Income	Income	Income
Tax Payable rate	30%	30%	30%	30%	30%
Tax Payable	(18,000)	(18,000)	(18,000)	(18,000)	(18,000)	(90,000)
After Tax Interest Income	42,000	42,000	42,000	42,000	42,000	2,10,000

Tax Effect on Bond Mutual Fund:

Taxes are paid only on redemption/withdrawal and the rates depend on the nature of gain. For Bond fund any redemption within three years is considered as short term capital gain (taxed at applicable individual tax bracket) and redemption after 3 years is considered as long term capital gain (taxed at 20% adjusted for indexation benefit- works out close to 10%)

Ex Mr X invest Rs 10 Lac in a bond mutual fund and decides to withdraw 6% income on yearly basis (to match Bank FD Cash flow) ; Mr X falls in a 30% tax bracket; then Mr X has to pay an average tax of Rs 1,730/Annum. (91% lower than bank FD)

	Year 1	Year 2	Year 3	Year 4	Year 5	Total
Withdrawal	60,000	60,000	60,000	60,000	60,000	3,00,000
Capital Gain (at 6% return)	3,396	6,600	9,623	12,474	15,165
Tax Effect	STCG	STCG	STCG	LTCG	LTCG
Tax Payable rate	30%	30%	30%	10%	10%
Tax Payable	(1,020)	(1,980)	(2,887)	(1,247)	(1,516)	(8,650)
After Tax Interest Income	58,980	58,020	57,113	58,753	58,484	2,91,350

 *STCG-Short term capital gain; LTCG- Long term capital gain

Conclusion: Bond Mutual fund taxes are applicable only on redemption while on bank FD’s taxes are applicable on accrued interest; Bank FD taxes would be 10 times higher than that of bond mutual fund. Bond Mutual fund provides higher return, offers better liquidity and most efficient in terms of taxes compared to Bank FD.

Retirement Planning: Balanced Fund Vs Fixed Deposit

Everyone would like to retire financially sound. However majority of the investors would build corpus for retirement over their working years by investing in fixed deposit instruments. FD return most of the times just cover inflation and thus real return (adjusted for inflation) in FD would be 0-2% and returns are taxable.

I advocate balanced funds offered by Mutual Fund Houses for retirement planning. Balanced funds invest in a mix of Equity (generally 60-70%) and bond (generally 30-40%). Equity investments aim at generating capital appreciation, while Bond investments provide capital protection and reduce fund volatility/risk.

Selected Balanced Fund Vs Fixed Deposit (Since Inception)

If an investor had invested Rs 1 lac in BSL Balanced 95 Fund in the year 1995 (at the time fund launch), his worth today would be close to Rs 56.5 Lac when compared to FD worth of Rs 5.03 Lacs; thus investment in BSL Balanced 95 fund would have made you rich by Rs 51.46 Lacs. All the selected funds have generated higher return than the FD in the long run

Selected Balanced Fund Vs Fixed Deposit (Last 5 Years)

If an investor had invested Rs 1 lac in BSL Balanced 95 Fund five years back his worth today would be close to Rs 2.15 Lac when compared to FD worth of Rs 1.46 Lacs; thus investment in BSL Balanced 95 fund would have made you rich by Rs 68,590. All the selected funds have generated higher return than the FD over last five years

Conclusion: Balanced fund with the mix of equity and bond can offer the best from both the asset class. Capital appreciation from equity & reduced risk from Bond. Selected Balanced funds clearly outperformed FD both in the short (over 5 year period) as well as long run (since Inception/fund launch)

Investor’s ability to take risk would be high when they have active income (Employed), higher income levels, longer investment horizon (still has sufficient time for retirement/essential commitment); If your current situation provides you enough flexibility to take risk then you should seriously consider putting your money work for you by investing in Balanced fund instead of FD. Plan well for happy & financially sound retirement

Feel free to place your comment and for any queries related to personal finance, you can reach me @ smartportfolioadvisors@gmail.com.