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Perhaps you prefer to choose your own investments but you’re not particularly fond of deciding which funds to invest in or how much of each to hold. Then you may be interested to learn there are funds that will do that job for you. They’re called “hybrid funds,” because they hold multiple asset classes in the same fund.
What is a hybrid fund and how does it work? Let’s drill down into the details.
What Are Hybrid Funds?
A hybrid fund is either a mutual fund or exchange-traded fund (ETF) that holds securities from multiple asset classes in a single fund. Some hybrid funds are even described as a “fund of funds.” This refers to a fund consisting of several different funds. For example, a certain type of hybrid fund may hold specific allocations in a stock fund, a bond fund, and cash.
The basic purpose of hybrid funds is to provide a fully diversified and balanced investment portfolio within a single fund. Some investors find this arrangement preferable to selecting and holding multiple funds. It avoids the need to choose specific funds and any concerns about rebalancing.
In that way, a hybrid fund becomes something of a standalone portfolio. The investor simply chooses which hybrid fund best matches his or her investment preferences. It also eliminates the need to pay a third party to manage multiple funds within the same account.
How Hybrid Funds Work
In most cases, a hybrid fund holds individual securities.
- Typically, that’s a combination of investing in stocks and bonds. Some funds hold a fixed allocation between stocks and bonds.
- Others have a provision to revise allocation percentages between stocks and bonds either at the fund manager’s discretion or on specific events.
- In addition, the specific type of hybrid fund may require allocation adjustments based on specific criteria, such as the age of the investor.
- Like other funds, hybrid funds come in a variety of risk levels. A conservative fund usually has a higher allocation of bonds than stocks. A moderate risk fund holds roughly equal allocations. And an aggressive fund has a much heavier weighting in stocks.
Types of Hybrid Funds
There are three broad classes of hybrid funds: balanced, blended, and target date.
Let’s look at each type in more detail.
This type of hybrid fund uses a fixed asset allocation between stocks and bonds. For example, a balanced fund may allocate 60% to stocks and 40% to bonds. In a typical balanced fund, the allocation remains fixed.
Use of the word “balanced” refers to the fund having a mix — or balance — between growth, income, and preservation of capital. The stock allocation provides growth, while income and capital preservation are provided by bonds.
Many balanced funds tie their allocations to popular indexes. For example, the stock allocation may be designed to match the performance of the S&P 500 index. In this way, balanced funds use a passive investment strategy, matching the market. This contrasts with actively managed funds, in which individual securities are actively traded in an attempt to outperform the general market.
- Because balanced funds are passively managed, they tend to have lower expense ratios than actively managed funds.
- For retired investors looking for income, the fund pays out the interest and dividend income rather than reinvesting it.
- A popular balanced fund is the Vanguard Balanced Index Fund (VBINX). It’s a moderate risk index fund with a 60/40 allocation between stocks and bonds and a low expense ratio of 0.18%.
- But some investors choose a fund with a more aggressive allocation. For example, the T. Rowe Price Capital Appreciation Fund (PRWCX) can allocate as much as 70% to stocks. But it also has a high expense ratio at 0.70%.
If balanced funds are a hybrid between stocks and bonds, blended funds are based on multiple equity (stock) funds. These aim to achieve balanced allocations between stock classes.
For example, the typical blended fund holds allocations in both growth stocks and value stocks. The two stock types are at opposite ends of the equity spectrum.
- Most investors favor growth stocks and ignore value stocks. But value stocks have strong fundamentals and low valuations (relative to growth stocks), so they can be excellent long-term investments. And value stocks add a level of stability to a portfolio precisely because the prices are relatively low.
- In a typical investment scenario, you’d need to hold both fund types separately. But a blended fund combines both into one fund. This eliminates the need to choose and manage two funds.
Target Date Funds
Target date funds maintain asset allocations based on a specific timeframe. Because they are time-specific, they’re commonly used for retirement planning. The objective is to match the target date of the fund with the retirement date of the investor.
For example, let’s say you’re 35 years old and you plan to retire in 30 years. Since it’s now 2021, you choose to invest in a target-date fund for the year 2050, roughly 30 years from now.
- In the early years, your fund invests primarily in stocks. That provides the kind of long-term growth needed to build a healthy retirement portfolio.
- But as you move closer to the target date, the allocation gradually shifts more heavily into bonds. This is based on the fact that as you get older, you have less time to recover from a serious market decline.
- By the time you reach retirement (around 2050), the fund will be invested primarily in bonds. That provides a mix of both capital preservation and income generation through interest on the bonds.
Some people refer to a target-date fund as a “fund of funds,” because it invests in funds for each type of allocation. One disadvantage, however, is that target-date funds often have high expense ratios. That’s because they have investment fees associated with the target-date fund itself, as well as the individual component funds.
One popular target-date fund is the Vanguard Target Retirement 2065 Fund (VLXVX). This fund comprises four different Vanguard funds covering U.S. and international stocks and bonds. And since the target is 2065, the fund is currently heavily weighted in favor of stock allocations.
What Are Aggressive Hybrid Funds?
A typical balanced fund holds a mix of 60% in stocks and 40% in bonds. Aggressive hybrid funds hold as much as 80% in stocks. That makes them a higher risk/higher return investment, which is where the term “aggressive” comes from.
- Aggressive hybrid funds are also actively managed. Rather than investing in index-based assets and merely tracking the underlying markets, they invest in individual securities. In the process, they attempt to outperform the market.
- This includes the use of arbitrage, which is not permitted in balanced funds. Arbitrage is a strategy in which securities are purchased in one market at a low price and sold in another market at a higher price.
- Aggressive hybrid funds can also concentrate primarily in growth and value stocks.
- Since they’re actively managed, aggressive hybrid funds have higher expense ratios. And while they seek to benefit from a mix of income and long-term growth, they have a higher risk of loss than with balanced funds.
What Is a Hybrid Mutual Fund?
Hybrid funds can be either mutual funds or exchange-traded funds. That said, mutual funds have features that distinguish them from ETFs.
- Most ETFs typically have no investment minimums, but a hybrid mutual fund may require a minimum investment. Some have entry points as low as $500. Others require $3,000 or more.
- Mutual funds may have load fees. These are essentially sales commissions for employees who buy and sell your interest in the fund. The fee may be 2% upfront (charged when you buy) or split with 1% charged upfront and 1% on sale.
- Most ETFs invest in index funds and are passively managed. But mutual funds are often actively managed. Actively managed funds trade frequently into and out of individual securities.
- Actively managed funds have higher expense ratios than most ETFs have.
Because of the potential for active trading, hybrid mutual funds are more likely to fall into the high risk/high reward category.
Do I Need Hybrid Funds?
Hybrid funds are best suited to investors who want to choose their own funds but prefer the convenience of a single fund that provides a fully diversified portfolio. That eliminates the need to hold individual securities or multiple funds.
Target date funds have become especially popular in recent years due to their applicability to retirement. You choose a target-date fund based on your expected retirement date. Then the fund allocation automatically adjusts to a more conservative mix as you approach your retirement date.
However, you may be better served investing through a robo advisor. These are automated, online investment services that work similar to hybrid funds but at a lower cost.
For example, robo advisors invest in index-based ETFs with very low expense ratios. And rather than charging load fees or investment fees like a hybrid fund does, they charge a low — and sometimes nonexistent — advisory fee.
Two popular robo advisors are Betterment and Wealthfront. Each charges an annual advisory fee of just 0.25%. That means you can have $10,000 managed for just $25 per year, or $100,000 for just $250 per year.
And if you don’t want to pay any fee, choose a robo advisor that doesn’t charge a brokerage fee or commission, such as M1 Finance. Here’s a quick comparison between all the three robo advisors:
Hybrid funds attempt to include multiple asset classes within a single investment fund. Though they accomplish that objective, they come with certain limits. High cost is one, and lack of control over specific allocations and investments is another.
But perhaps the biggest limitation is the variety of hybrid funds available. Balanced, blended, and target-date funds each have a unique investment strategy. You need to know exactly which type you’re investing in, as well as the strategy the fund employs. That’s not always readily apparent to inexperienced investors.
If you like the idea of automatically managed, multiple asset allocations, you may be better served using a robo advisor. Though most won’t allow you to choose your own investments, they adjust your portfolio allocations based on your personal risk tolerance, investment goals and time horizon.