Asset Allocation Mutual Funds

Asset allocation mutual funds, including balanced mutual funds, can satisfy the large-cap stock and high-quality bond components of your portfolio if you're content with their one size fits all approach to basic diversification. You'll find that there are three varieties of asset allocation funds: actively managed, passively managed and targeted maturity.

Actively managed asset allocation mutual funds apply the same analytical tools used to manage stock and bond funds to manage the stock and bond components of these funds. Asset allocation mutual funds are very diverse in their objectives and strategies. Although many stick close to the traditional 60/40 stock/bond allocation, some have moved to allocations that are less traditional and more complex, thus providing investors more efficient core portfolios. Some of these funds give the fund manager full discretion as to asset allocation, meaning that the fund could possibly be 100% invested at any given time in any of the asset classes allowed by the fund's prospectus rather than some blend of the asset classes. Needless to say, due to their diversity, it's hard to compare these funds.

Some of the actively managed asset allocation mutual funds have done very well over the years, due primarily to the accumulated skills and knowledge of the fund managers. However, they've done well mostly by being heavily invested in the right asset classes at the right time, therefore, having one or more good, thoroughly indoctrinated protégés is crucial to the long-term success of these funds. But most of them only get the timing right occasionally or, at best, they will have one good long run, which a few are likely to do just based on probability.

If you find an actively managed asset allocation mutual fund you like with a good long-term record of making the right calls, it might make a good core holding. But other asset classes need to be added to round out your portfolio.

Balanced mutual funds maintain a predetermined allocation between stocks and bonds, such as 60% stocks and 40% bonds, with an allocation somewhere in the neighborhood of 60/40 being the most common. The predefined allocations are maintained within a range that is stated in the funds' prospectuses. Balanced mutual funds are often comprised of two or more index funds, thus the only management effort required is maintaining the balance within the stipulated bounds, which is reflected in their low management fees.

Balanced mutual funds are pretty rigid. They stick with the same blend with no regard to the movement of the markets, which isn't necessarily bad. In any given year, 80% of actively managed funds fail to beat their benchmark index. Add to that the fact that there are virtually no fund managers that have consistently been successful at timing the markets long-term and the lower management fees charged by passively managed funds and you have a pretty good case for the passive strategy.

A passively managed balanced mutual fund also could make a good core holding. And the same caveat applies: Other asset classes need to be added to round out your portfolio.

Targeted maturity mutual funds can be comprised of individual securities and/or index funds and are managed with the expectation that they will be liquidated at the target date or maintained in their final conservative form after the target date. As the target date approaches, the asset mix becomes more conservative, i.e., the asset allocation shifts toward fixed-income investments and may eventually shift to 100% fixed-income, depending on the funds' stated objectives and strategies.

Targeted mutual funds are designed to make the appropriate transition to a more conservative portfolio as you approach a date when your life situation is expected to change or you expect to liquidate your portfolio for some reason. This could be your planned retirement or the beginning of a child's college years.

Targeted mutual funds morph over their life from a stock-heavy blend of stocks and bonds to all or mostly bonds and cash-equivalents. The terminal composition varies from fund to fund, so you need to select one the best suits your needs.

World balanced mutual funds, a.k.a. Global balanced mutual funds, are essentially the same as actively and passively managed domestic asset allocation mutual funds except they have a worldwide selection of debt and equity securities. Making one of these funds your core holding is much more difficult, as it requires that you determine the worldwide allocation of the fund's assets before you can determine which other assets you need to round out your portfolio.

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