Two basics of investing are asset allocation and diversification, according to the Securities and Exchange Commission. In a nutshell, those two concepts sum up the financial advice your grandmother might give you: Don't put all your eggs in one basket, and make sure the eggs come from different chickens. When it comes to your investments, having a mix of stocks and bonds in a single mutual fund gives you both a diversified portfolio and professional asset allocation.
Stocks vs. Bonds
Stocks and bonds represent two different kinds of investment categories. Stocks are equity investments; they give you an ownership position in a company. You can make money on stocks through dividend payments, which represent your share of the company's profits, and through capital gains if you sell the stock for a profit. Bonds represent a loan to a company, municipality or governmental organization. Bonds typically provide a steady stream of interest income plus the promised return of the bond's face value upon maturity.
Pros and Cons
Stock prices have traditionally been more volatile than bonds, but over long periods of time, stocks tend to offer higher returns. Bond prices have traditionally been more stable than stocks, but they provide lower returns. During the 50-year period from 1959 through 2008, stocks returned an average of 9.18 percent per year, while bonds provided an annual return of 6.48 percent, according to the Russell Investments website. Just because stocks have a long-term advantage doesn't mean they always outperform bonds. In some markets, particularly during periods of financial uncertainty, bonds may outperform stocks.
A balanced fund is a mutual fund that intentionally invests in a particular mix of stocks and bonds. The typical asset allocation of balanced funds is 60 percent stocks and 40 percent bonds, according to the CNN Money website, but each mutual fund is different and has its own investment objective that influences the mix of stocks and bonds. Balanced funds tend to provide more conservative returns than more aggressive mutual funds during up years, but they suffer smaller losses during down years. The combination of diversification and asset allocation between stocks and bonds in a balanced fund acts as a buffer against loss while providing the opportunity for steady growth and income.
The "Wall Street Journal" advocates rebalancing your investment portfolio each year. This involves looking critically at your investments for both growth and losses. For example, if you have an individual portfolio of 60 percent stocks and 40 percent bonds at the beginning of the year, and stocks did exceptionally well, at the end of the year your portfolio might contain 70 percent stocks and 30 percent bonds. You would need to sell some stocks and buy more bonds to return to your 60/40 ratio. With a balanced mutual fund, the fund's manager constantly maintains the balance between stocks and bonds, so you don't have to.
- Russell Investments: Stocks & Bonds
- Daily Finance: Mixed-Asset Mutual Funds Offer the Best of Both Stocks and Bonds
- Wall Street Journal: How to Buy a Mutual Fund
- CNN Money: Why Balanced Funds Are Still Sweet
- Securities and Exchange Commission: Beginners' Guide to Asset Allocation, Diversification, and Rebalancing