Balanced funds offer exposure to both debt and equities. While equities offer to beat inflation, debt offer much needed stability to the portfolio
Given the rising life expectancy, inflation and changing life style, the retirement corpus size is significantly rising. We have noticed 9 out of 10 families in urban places expecting a significant shortfall in their retirement corpus. Families can deploy many strategies to bridge this gap. Relooking at retirement age, prioritizing retirement savings, optimizing retirement expenses baseline, targeting higher ROI for retirement savings and re-working on real estate portfolio can be good starting point.
Aiming a higher ROI
Equity as an asset class can help to beat inflation, save taxes, earn higher ROI and thus build a significant corpus in the long run. It is observed that many families tend to stay away from equities due to the fear of price fluctuations that inevitably come along in the short term. It is strongly recommended to leverage the mutual fund route to get exposure to equity asset class. Within equity mutual fund, there are categories that can suit families which are afraid of fluctuations. Balanced or hybrid Funds are one such category.
What are balanced funds?
Balanced funds invest a part of the corpus in equity & the remaining in debt securities. The equity part attempts to give decent returns and debt part gives stability in the portfolio. There are three categories of balanced funds i.e. hybrid equity, hybrid debt aggressive & hybrid debt conservative. In hybrid equity, the equity exposure is at least 65% to 70% & rest is held in debt securities. This gets favorable tax treatment i.e. holdings of one year and above get classified in long term capital gain category which is taxed at nil rate.
In case of hybrid debt aggressive funds, the debt securities are invested for around 80% of the corpus and the rest is held in equity stocks. In hybrid debt conservative, the debt securities are invested for around 90% of the corpus and the rest is held in equity stocks. The tax treatment for both hybrid debt aggressive and hybrid debt conservative is long term capital gains for holdings of three years and above. The long term capital gain tax applicable here is 20% of the indexed gain. Based on risk appetite and retirement corpus status, families can select the suitable category.
How have the balanced funds performed? How volatile are they?
Observing from last 10 years cumulative performance (as on 31-May-2015) hybrid equity oriented funds category is less volatile than the CNX Nifty and the large cap fund category. From a performance stand point this category has given higher or almost same returns than the Sensex as well as the large cap category. The returns of hybrid debt oriented aggressive and hybrid debt conservative category are relatively lower but still attractive considering the long term capital gain indexation related tax benefits.
How they can help
These funds have inherent asset allocation mechanism as they periodically rebalance the funds. The hybrid equity funds give tax advantage and even with exposure to mid & small size companies, the debt component adds stability to returns. Even if a family stays with hybrid debt conservative or hybrid debt aggressive category, there is a significant tax saving due to capital gain norms for holdings beyond three years. When a family saves for retirement, expectation is to save in a bit conservative way and the balanced funds can be a good fit here.
But watch out
Some experts prefer to invest separately in equity & debt funds. Based on specific situations and preference of the families, this can give more flexibility. Expense ratio of most balanced funds is observed to be closer to diversified equity funds’ expense ratio. Many balanced funds invest sizable corpus in mid & small size companies. This may not be suitable to first time, conservative or retired families.
To avoid getting distracted from short term volatile nature of the equity asset class, families should link the investment to the goal of retirement corpus and invest only via SIP route.
Rohit is SEBI Registered Investment Advisor. Rohit has founded Getting You Rich, a Financial Planning firm