Balanced funds attempt to provide investors with the best of both worlds. They aim for growth (through a high equity allocation) and stability (through the debt allocation) of the investment.

Despite this, they have failed to appeal to many. That was the past. Now, this has changed. In May, when the stock market began to decline, the debt component made all the difference.

Over the last three months (data as on August 4, 2006), the diversified equity category lost over 19% on an average. The corresponding figure for balanced funds was 12.7%.

Alternately, we can also look at the returns from January 1, 2006, till August 4, 2006. The average balanced fund delivered a return of 7.4% while the average diversified equity fund delivered a return of 5.4%.

Why balanced funds are good

Balanced funds invest in equity and debt. Hence, you get growth coupled with a cushion should the market plunge. This makes them an excellent option for investors who are planning a foray into stocks but are also wary of volatility.

Since it is wise for every investor to put part of his money in equity and debt, investing in such a fund makes sure you do this automatically. If an investor has to personally plan his investments in equity and debt, it can be very time consuming. 

When the stock market shoots up, investors tend to put more money in shares. Investing in a balanced fund ensures that a fixed proportion stays in equity and debt.

What you have to be wary of

A pure equity fund has the advantage of long-term capital gains. If you sell the units after a year of buying, you pay no tax on the profit. This is not true of a debt fund.

Before Budget 2006, a balanced fund that had more than 50% of its total investments in equity was considered an equity fund. So, investors got this tax benefit.

After the Budget, this ratio has been hiked to 65%. To pass on this tax benefit, fund managers will have to put at least 65% in equity.

So, if you are wary of that much investment in equity, pick up a fund that invests less than 65% of its portfolio in stocks.

Here are some funds that have increased their equity allocation after the Budget.

Picking the right fund

Depending on the risk and performance, we give funds a star rating -- five stars being the best and one star, the worst.

The five-star funds are Magnum Balanced and HDFC Prudence. The four-star ones are Canbalance II, DSPML Balanced, FT Balanced, Kotak Balance and Sundaram BNP Paribas Balanced.

Tomorrow, we shall look at the some funds and tell you which ones make for a good investment.

Part II: The best balanced funds