No single investment can do it all - provide growth potential, protect you against risk, produce income, etc. That's why most investors own different types of investments.
A balanced portfolio is an option for obtaining and coordinating investments that play different roles.
This article takes a look at balanced portfolios, including:
- How managed portfolios work
- What a balanced portfolio is, and the benefits of balanced investment accounts
- Potential drawbacks of balanced accounts
- Different types of balanced portfolios
- How to get a balanced portfolio
What is a Portfolio?
Think of an investment portfolio as a sports team.
Players on a team are not thrown together randomly. Each is selected because they have certain characteristics, and they're assigned roles suited to those characteristics.
Once the team is put together, it is managed to follow certain strategies, and periodic adjustments are made to the make-up and approach of the team.
In a similar way, a portfolio is a coordinated collection of investments.
You could acquire different investments in an uncoordinated way, maybe buying a stock you heard good things about, then at some other time buying some bonds to produce income all the while keeping a certain amount of your money safely in a bank deposit account.
You would have different investments playing different roles, but it's not like they'd be coordinated in any meaningful way.
A coordinated portfolio not only assembles different types of investments, but it does so with thought to the proportions of the portfolio each one represents. It is managed with an awareness of how different investments interact, and adjustments are made periodically to keep the investments in sync or to respond to opportunities as they arise.
As with a team, a portfolio is more than just a number of disconnected parts; rather, a portfolio is a collection of assets designed to work together to meet a goal.
What is a Balanced Portfolio?
A balanced portfolio pursues the idea of coordinating investments by incorporating assets that have clearly different risk/reward characteristics:
- Stocks, for example, are an asset class which generally has strong return potential over the long run, but which is prone to severe downturns from time to time.
- High-quality bonds are more of a slow-and-steady asset, producing regular amounts of income but having limited long-term upside.
- Other asset classes, from cash equivalents to real estate and commodities also have very distinct investment characteristics.
The notion of a balanced portfolio is to recognize that there is value in having more than one type of investment.
Also, if you're going to own different asset classes, it's best to coordinate the specific holdings and the amounts you own rather than to put them together randomly.
While the name "balanced portfolio" may suggest a 50/50 split between stocks and less risky assets, it is widely used to describe any portfolio designed to own significant amounts of different asset classes. The proportion in which those asset classes are owned depends on the goals of the portfolio.
To a large extent, the nature of a balanced portfolio is not necessarily to strike a balance between different types of assets such as stocks and bonds. It's more to balance conflicting goals such as pursuing a high return on investment and protecting against large losses.
Benefits of a Balanced Investment Account
Why would you consider a balanced portfolio when you could buy different types of investments separately?
Part of it goes back to the team analogy. You should strive not only for a variety of different investments, but also for investments that fit well together.
In fact, asset allocation is often considered the most important of all investment decisions, so having it professionally coordinated rather than occurring randomly makes sense.
Also, think of a balanced portfolio as a type of one-stop shopping. Rather than deal with one account for stocks, another for bonds, yet another for your cash reserves and still more for other investment types, having everything in one place would make your investment program easier to monitor.
Finally, once you obtain a mix of different investments, that mix needs to be kept in proportion. Different assets typically go up and down in value at different times. Rather than have this randomly skew the proportions of your holdings, it's helpful to have them adjusted periodically as part of a coordinated approach in a balanced portfolio.
Arguments Against Balanced Portfolios
Why doesn't everybody use a balanced portfolio?
Simply put, there are differences of opinion on whether this is the best investment approach. Some people question whether a single investment firm can really be good at managing several different types of investments. They argue that it's better to find a specialist for each investment class.
Some argue that a balanced portfolio might not be the most cost-effective approach. Riskier investments like stocks tend to require higher management fees than more stable assets like cash equivalents. If you have a blend of risky and steady assets, you might be paying a higher fee than necessary for the more conservative assets.
If you're considering a balanced approach, you should be aware of those criticisms. You may well decide that the benefits of having a centrally coordinated portfolio are worth these potential flaws.
Types of Balanced Portfolios
The term "balanced portfolio" is not limited to an even, 50/50 mix between stocks and bonds. A wide range of portfolios with mixed asset classes are available, representing everything from conservative to aggressive asset mixes.
Beyond the differing risk levels, there are various ways to approach the management of a portfolio's asset mix too.
Here are some different types of balanced portfolio:
- Separate balanced accounts
This is a single, individualized account consisting of securities chosen and monitored by a professional investment manager. While a separate account is often more expensive than other options, it has the advantage of allowing you to customize your investment guidelines and engage in tactics like tax-loss selling that are tailored to your needs.
- Balanced funds
Besides costing more, separate accounts generally have to be fairly large to be managed efficiently. Mutual funds allow investors to have broadly diversified, professionally managed investments even with fairly small amounts of money.
Mutual funds are built around specific investment guidelines - so if you want a balanced fund, it is important to choose one that is designed to incorporate different asset classes and coordinate the mix of those asset classes over time.
- Robo-advisor programs
These are programs that use automated formulas to put together a collection of investments that match your needs and circumstances. Given that people generally have goals that involve a mix of growth and preservation of capital, robo-advisor programs will often result in a balanced portfolio made up of funds and other investments representing different asset classes.
- Fixed-allocation portfolios
One way to approach creating a balanced portfolio is to build it around a target allocation based on a specific risk profile. That target allocation is then maintained constantly.
Keeping the asset allocation constant does not mean these portfolios don't do anything. The mix of asset classes needs to be rebalanced periodically to maintain the desired target, and investments within each asset class may be changed over time. Maintaining a fixed allocation is also referred to as a "passive asset allocation approach."
- Opportunistic portfolios
As the name suggests, an opportunistic portfolio is one that seeks to take advantage of market opportunities as they present themselves. In the context of a balanced portfolio, this means adjusting the allocation according to which asset classes the manager thinks look most attractive. This approach is also sometimes referred to as an "active asset allocation approach."
- Target date funds
Target date funds are sort of a hybrid between an active and a passive allocation approach. They are based on the assumption that the investor plans to retire on a stated date.
Different target date funds are based on different dates, so investors can choose the one that best matches their retirement plans. The asset mix is set according to the long-term risk/reward goals associated with the fund's target date. Then the allocation is gradually adjusted over time, not in response to market conditions but to reflect the way risk/reward characteristics change as the target date approaches.
These varied approaches are designed for different preferences and needs, giving you multiple options of finding the best fit for your situation.
Where to Find a Balanced Portfolio
There are a number of ways you can get a balanced portfolio.
If you have a substantial amount of money to invest (typically well over $100,000), one option is a separately managed balanced account. While there are thousands of investment advisors who manage client portfolios, it is important to find one that specializes in balanced accounts.
Some online brokers might also have managed account programs that provide access to balanced portfolios.
If you don't have a large enough investment for a separate account, there are plenty of balanced mutual funds from which to choose. These are available directly from mutual fund companies as well as from online brokers. Target date funds are a popular option on 401(k) investment menus.
Robo-advisors give you yet another option for coordinating different asset classes. These programs are based on formulas that automatically match investments with your needs and characteristics.
Diversifying across different asset classes can involve a lot of work. The various ways you can get a professionally managed, balanced portfolio can make it much easier.
Another option is to work with a financial advisor that is trained in balancing investments. You can explore some of the options available below: