Last Updated on December 18, 2021 at 10:51 pm
A discussion on the differences between dynamic mutual funds and balanced mutual funds. Exploring this topic is a nice way to understand some portfolio management basics. Thanks to Arun for asking this question when I suggested that dynamic equity funds are not for those who wish to chase returns.
First, we need to define some terms.
What is an asset?
An asset is a specific type of security that can be traded. Example of assets are stocks (equity), bonds,gold, silver, oil, derivatives, arbitrage, etc.
What is an asset allocation?
Asset allocation refers to the percentage exposure to each asset class in a portfolio of securities. Sometimes a portfolio will have multiple assets and sometimes only a single asset. Asset allocation can vary with time. For example, a mutual fund can hold 80% stocks and 20% bonds in one month and 65% stocks and 35% bonds in the next month and so.
🔥Secure your future with our Robo-advisory tool trusted by over 3,000 investors and advisors. From effortless retirement planning to funding your children’s biggest dreams, turn your financial goals into reality. 🔥
Subscribe for money management solutions via email! (Link takes you to our email sign-up form) Join 32,000+ readers in our community.
👉 New Tool Alert! NaviPlan: A Privacy-Focused Multi-asset Tracker and Goal Planner 👈
A single asset class portfolio is often a point of view. A portfolio with 65% stocks and 35% arbitrage holdings is a single asset class portfolio from the viewpoint of the taxman.However, from the point of view of volatility, it is two asset portfolio. Arbitrage holdings resemble (ultra) short-term bonds with respect to risk and reward.
Similarly, a mutual fund holding other equity mutual funds is a debt fund in the eyes of the taxman and an equity fund in terms of risk and reward.
Again, a fund holding international stocks or international funds is a debt fund wrt tax and equity fund wrt risk/reward.
Gold is taxed similar to debt funds but resembles equity wrt risk and reward.
There are many ways in which the asset allocation of a portfolio can be changed. This is the main focus of this post.
Strategic asset allocation
In this case, a target asset allocation (eg. 70% stocks, 30% bonds) is decided. This can be either considering the risk profile of the goal or the risk appetite of the investor or a combination of both. This is a key step in investing which many DIY investors do not seem to understand. Read more: Deciding on asset allocation for a financial goal.
Once a target allocation is decided, the objective is to stock to it and if there are deviations, rebalance the portfolio periodically.
Conventional equity-oriented balanced funds which did not dabble in derivatives/arbitrage are nice examples of this strategy. They rebalance each month typically. Rebalancing is only of the key reasons why such balanced funds can beat diversified equity funds.
Debt-oriented funds with equity ranging anywhere from ~15% to less than 65% also fall in this category. Monthly income plans are a subset which typically have stocks less than 30-35% at all times.
Equity savings funds contain a mix of stocks, fixed-income and arbitrage holdings. Although individual allocations can vary, dramatic variations are unlikely.
Then there are funds which roughly hold equal amounts of stocks, bonds and gold. Examples -Axis triple advantage fund, Quantum multi-asset fund etc.
The strategy in this case, is to reduce portfolio volatility by holding approximately constant amounts of certain asset classes and rebalancing them periodically.
The state of the equity,bond or gold market will not cause deviations from the strategy.
Tactical asset allocation
If the state of the market (economy as a whole) is used as a guideline to determine asset allocation, it is referred to as tactical asset allocation. In this case, the asset allocation can swing by huge amounts.
The main aim of this tactic is to reduce the risk taken per unit return obtained. It is incorrectly believed this technique also known as market timing will yield better returns.
Dynamic equity funds belong to this category and typically their volatility levels and returns are lower than that of balanced funds (strictly an apple vs orange comparison).
The many ways in which these funds invest are detailed in this post, Performance of Dynamic Asset Allocation Mutual Funds
Without arbitrage holdings, a dynamic asset allocation fund can swing from more than 65% equity holdings (equity fund as per taxman) to less than 65% (debt fund as per taxman).
With arbitrage holdings, the fund will remain an equity fund from pov of the taxman at all times.
The hybrid equity-oriented category of value research contains funds that adopt both asset allocation strategies. So it is important to read the scheme information document and understand the investment strategy.
The above discussion is summarised in this figure.
When to use dynamic mutual funds
The key objective of these funds is to reduce volatility. Therefore a person with low-risk tolerance and scared of losses (esp when the market is at an all-time high) can use such funds for goals which are 10+ years away. They are not suitable for durations lower than that.
When to use balanced mutual funds
An equity-oriented balanced fund can serve a portfolio fund (no other instrument needed) for the initial years of a 10+ year goal. Dangerous to use for shorter periods.
An equity savings fund can (as per current tax laws) replace debt mutual funds for 10+Y goals for those who don’t mind some risk for tax-free capital gains. They can also be used for 5-10Y goals. Lower than that, the risk increases.
A debt-oriented balanced fund can be used for short-term goals and also for investing a part of the retirement corpus. Instead of choosing the dividend option which is taxed at 28.325% at source (Dividend Distribution Tax DDT), the growth option with manual or systematic withdrawals is better. Read more:How and When to use Mutual Fund Monthly Income Plans
Multi-asset mutual funds are all-weather portfolio funds. That is, they can be used regardless of market conditions (bull, bear or sideways run) for durations above 5Y or so. Their focus is on reducing volatility by concentrating (a bit too much) on diversification. Read more: Diversification will lower investment returns!
When to use single-asset mutual funds
These mutual funds invest in a single asset class at all times and can be used to build an investment portfolio. Some people prefer independent products for each asset class instead of a mixed asset class fund. This is a personal preference.
To build a portfolio, it is important to recognise risk and how they depend on duration. Read more: Equity investing: How to define ‘long-term’ and ‘short-term’.
Join 32,000+ readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email! (Link takes you to our email sign-up form)
Use our Robo-advisory Tool to create a complete financial plan! More than 3,000 investors and advisors use this! Use the discount code robo25 for 20% off. Plan your retirement (early, normal, before, and after), plus non-recurring financial goals (such as child education) and recurring financial goals (such as holidays and appliance purchases). The tool helps anyone aged 18 to 80 plan for retirement, plus six non-recurring and four recurring financial goals, with a detailed cash flow summary.
🔥Join our community of 9000+ users! 🔥Avail massive discounts on our courses + freefincal investor circle!
Track your mutual funds and stock investments with our Google Sheet!
We also publish monthly equity mutual funds, debt and hybrid mutual funds, index funds, ETF screeners, as well as momentum and low-volatility stock screeners.
You can follow our articles on Google News
We have over 1,000 videos on YouTube!
Podcast: Let's Get RICH With PATTU! Every single Indian CAN grow their wealth!
You can watch podcast episodes on the OfSpin Media Friends YouTube Channel
- Do you have a comment about the above article? Reach out to us on Twitter: @freefincal or @pattufreefincal
- Have a question? Subscribe to our newsletter using the form below.
- Hit 'reply' to any email from us! We do not offer personalised investment advice. We can write a detailed article without mentioning your name if you have a generic question.
About The Author
Dr M. Pattabiraman (PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over 14 years of experience publishing news analysis, research and financial product development.
Connect with him via Twitter(X) LinkedIn YouTube
Our flagship course! Learn to manage your portfolio like a pro to achieve your goals regardless of market conditions! More than 3,500 investors and advisors are part of our exclusive community! Get clarity on how to plan for your goals and achieve the necessary corpus no matter the market conditions! Watch the first lecture for free! One-time payment! No recurring fees! Lifelong access to videos! Reduce fear, uncertainty and doubt while investing! Learn how to plan for your goals before and after retirement with confidence.
Increase your income by getting people to pay for your skills! More than 900 salaried employees, entrepreneurs and financial advisors are part of our exclusive community! Learn how to get people to pay for your skills! Whether you are a professional or small business owner seeking more clients through online visibility, or a salaried individual looking for side or passive income, we will show you how to do it by showcasing your skills and building a community that trusts and pays you. (Watch the 1st lecture for free). One-time payment! No recurring fees! Lifelong access to videos!
Our book for kids: “Chinchu Gets a Superpower!” is now available!
Must-read book even for adults! This is something that every parent should teach their kids right from their young age. The importance of money management and decision making based on their wants and needs. Very nicely written in simple terms. - Arun.
Buy the book: Chinchu gets a superpower for your child!
How to profit from content writing: Our new ebook is for those interested in getting a side income via content writing. It is available at a 50% discount for Rs. 500 only!
We publish monthly mutual fund screeners and momentum, low-volatility stock screeners.
About freefincal & its content policy
Freefincal is a News Media organisation dedicated to providing original analysis, reports, reviews and insights on mutual funds, stocks, investing, retirement and personal finance developments. We do so without conflict of interest and bias. Follow us on Google News. Freefincal serves more than three million readers a year (5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified with credible and knowledgeable sources before publication. Freefincal does not publish paid articles, promotions, PR, satire or opinions without data. All opinions will be inferences backed by verifiable, reproducible evidence/data. Contact Information: To get in touch, please use our contact form. (Sponsored posts or paid collaborations will not be entertained.)Connect with us on social media
Our publications
You Can Be Rich Too with Goal-Based Investing
Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want
Your Ultimate Guide to Travel
