As regular readers have probably noticed, Darrow Kirkpatrick of Can I Retire Yet  is one of the writers most frequently included in my weekly roundups. Ive been enjoying his writing since I first encountered it, so when I met Darrow in person at the Financial Blogger Conference this year, I invited him to author a guest article for this site. I hope you enjoy it.

Balanced funds are mutual funds that combine stocks and bonds into a single investment. Generally they stick to a fixed asset allocation, within certain ranges. Balanced funds have traditionally been favored by conservative investors looking for safety, income, and modest growth. In a word, theyre boring !

For most of my journey to early retirement, I had no interest in balanced funds. I dabbled in individual stocks, then gradually shifted to passive index funds during my heavy accumulation years. Towards the end of that time, as I focused more on safety and retirement income, balanced funds appeared on my radar.

At some point I took a small position in Vanguard Wellesley Income. Then something curious happened. Whenever I had free cash to invest, Id scrutinize my existing holdings plus my investing wish list. After some research, number crunching, and pondering, Id often just put the money in Wellesley Income! Over time, that one fund has grown to constitute about one-third of my portfolio.

Why did I keep choosing this one balanced fund? Because, regardless of the economic cycle, market cycle, or my own personal life cycle, it was nearly always an appealing investment.

The bond component of a balanced fund tends to dampen out the volatility of the stock market. A balanced fund wont rise quite as high in the good times, but it will fall far less in the bad times, and youll generally make back those dips in reasonable order. So, over time, a balanced fund can limit the stock markets swings, while delivering much of its returns.

And, while its not guaranteed, the stock component of a balanced fund makes the fund more likely to keep up with inflation than a bank CD, a bond, or a bond fund.

Helping You Avoid Mistakes

Another research-documented reason to like balanced funds: They help you to avoid common behavior that leads to investing mistakes.

To appreciate the evidence for this, you first need to understand the concept of investor returns as distinguished from fund returns. Were all familiar with the annual returns that mutual funds report in their glossy ads. But investor returns are what the average investor actually earns from the fund.

Why would those numbers be different? Consider a fund that has a great quarter and goes up 5% early in the year. Thats approximately a 20% annual return. Investors see that great return and pile in. Then the fund flat lines for the rest of the year. So it winds up the year by earning 5%, while most of its investors earned nothing. Thats investor returns.

In 2011 Morningstar completed a study on the gap in investor returns how individual investors do compared to their funds overall returns. Heres a snapshot of what they found: In 2010, the average domestic stock fund earned a return of 18.7% compared with only 16.7% for the average fund investor a 2% difference. For the trailing three years, that gap was 1.28%.

However it was a different story for balanced funds: The gap between investor and fund performance in 2010 was only 0.14%, and just 0.08% for the trailing three years. Results were even better for the trailing 10 years. And results were similar for target-date funds and moderate- and conservative-allocation funds close kin to balanced funds. As anybody who has crunched retirement numbers knows, a 1-2% difference in annual return over long periods can easily add up to tens of thousands of dollars!

Why do individual investors do better when they are buying and holding balanced funds? Its probably because balanced funds dont tend to incite fear or greed two emotions that can be lethal to investment performance. Balanced funds are easier to live with.

Its like the difference between a family sedan and a race car. The race car might have awesome performance, in the right hands. But, for those of us who arent full-time professional drivers, there are much better vehicles for driving around a city. Its the same with investing: For most people, a vehicle with predictable behavior, that they can handle, will produce better results. [Mike’s note: That’s my bolding.]

Using a Balanced Fund In Your Portfolio

Should a balanced fund (or a target-date or allocation fund) make up your entire portfolio? Thats a viable option for many. But it may not be possible, given the investment choices in your retirement plan. Or you might want the level of control offered by individual index funds or ETFs. But a balanced fund could still play a useful anchoring role in your portfolio, while serving as a mechanism to diversify or automate part of your rebalancing strategy. Thats how Wellesley Income functions in my portfolio.

Which balanced fund might be best for you? Vanguard Wellington and Wellesley Income have long and enviable track records, and have worked well for me. But note these are actively managed funds. While they have extremely low expenses 0.25% for Wellesley Income investor shares and 0.18% for Admiral shares, for example their managers do trade positions in an attempt to enhance performance. Mike makes a good case for the passive index-based Vanguard LifeStrategy Moderate Growth Fund, largely because of the increased international exposure. And if I had it to do over, Id probably choose one of the LifeStrategy funds too.

In the end, only you can choose whats right for you. But, whatever you decide, remember this principle: your long-term investing behavior is far more important to success than the exact investments you pick, the exact asset allocation you choose, or the rebalancing strategy you implement. As it turns out, balanced funds just make it easier for you to behave well!

Darrow Kirkpatrick is an author, software engineer, and investor who retired at age 50. He now writes regularly about saving, investing, and retiring at Can I Retire Yet? He is married to a schoolteacher, has a son in college, and is an experienced rock climber and enthusiastic mountain biker.