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These schemes allow beginners to learn tricks of the trade, and slowly progress to pure equity/debt
Lately, the government has been on an overdrive about financial inclusion and financial literacy. In its endeavour, it has involved almost all the financial regulators and therefore the financial institutions and entities under those regulators. Like other financial intermediaries, mutual funds too are involved in financial inclusion, trying to get new investors into their fold.
Within the mutual fund space, there are various schemes from which investors can choose. For beginners who are not very familiar with how mutual funds work and how they can benefit from it by investing for the long term, balanced funds are one of those entry-level schemes.
However, before we proceed further, there is one caveat: None of the funds called a balanced fund is balanced with 50% in equity and 50% in debt. They are always tilted on the side of equity, mostly 65% or above. And this is done mainly to take advantage of a tax law that allows lower taxation for all those mutual fund schemes that have invested at least 65% in equities.
How does a balanced fund work?
In these schemes, often there are two fund managers — one managing the equity part and the other the debt part. This is a kind of a mix-and-match situation to give investors the best of expertise on both debt as well as equity sides. While the equity part brings in some element of risk, the debt part is aimed at giving some amount of stability to the scheme.
So for those investors who are being initiated into the mutual fund fold, when they invest in these funds, over time they get to understand how the debt part works and also how the equity part works. And as they stay invested and learn the tricks of these assets, they can slowly move to pure equity and pure debt funds, MF industry officials say. The best thing here is that investors get a taste of an equityoriented portfolio.
What are the advantages?
One of the big advantages of a balanced fund is that even through part of your investments are in debt, you don't have to pay higher taxes on the income from the debt part, according to an official with a domestic mutual fund. On the other hand, if you invest in debt and equity separately, you may have to pay higher taxes on your income from debt investments.
This is because of the tax rule stated earlier which allows favourable tax treatment to mutual fund schemes with 65% or more invested in equities. Under this tax rule, once a mutual fund has paid securities transaction tax (STT), the scheme need not pay any tax and the investors need not pay tax for longterm capital gains.
What to watch out for...
Investors in balanced funds, however, need to learn the tricks of the trade and since these funds are invested in debt as well as equity, they should learn to contain their expectations. Often investors in balanced funds expect returns as good as equity funds when the equity market is good, and returns as high as debt funds when the fixed income markets are doing well.
Financial planners and advisors also point out some disadvantages that come with balanced funds. For one, if there is a bull run in the equity market and one wants to sell part of his/her holdings to take some profit home, he/she has to compulsorily sell the debt part also, even if some growth opportunities are still left in the debt portion. So if one is invested in debt and equity funds separately, then the investor can sell separately depending upon how the market is.
They also say that some of the balanced funds are very aggressive and at times take the equity holdings in their portfolios to over 75%. But such an approach may expose first-time investors to some unwarranted risks and, if things go bad, may even turn them away completely from the mutual fund industry itself.
In addition, financial planners say that, although these funds are good bets for firsttime investors, it is difficult to get a fund in which the equity fund manager as well as the debt fund manager are both very good in their respective areas.
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