What Are Hybrid Funds?

Definition and Example of Hybrid Funds

Hybrid funds are mutual funds or exchange-traded funds (ETFs) that invest in more than one type of security, such as stocks and bonds. They allow investors to own a mix of different elements that typically exist in two or more funds while investing in a single mutual fund. This makes hybrid funds valuable for investors who want a stand-alone option. They’re also good funds for beginners or as core holdings in a complete portfolio of mutual funds.

How Hybrid Funds Work

Hybrid funds usually hold a combination of stocks and bonds. The asset allocation can remain fixed or change over time, depending on the bond type.

A fund will have a stated objective, such as aggressive, moderate, or conservative growth. This indicates both the level of risk and the type of growth the fund is likely to experience.

It can make sense for many investors to buy mutual funds that focus on multiple objectives, asset classes, or security types rather than just one investment type. Hybrid funds allow investors to increase their investment diversification with a single holding.

Types of Hybrid Funds

There are two main types of hybrid funds: balanced funds and target-date funds.

Balanced Funds

The asset allocation in balanced funds remains fixed over time. These funds generally fall into one of three classifications: conservative, moderate or aggressive.

Conservative funds hold more bonds and fewer stocks. They’re safer investments with less likelihood of risk, as well as slower growth.

Moderate funds have a balanced allocation of assets for medium risk and medium growth. A moderate fund might hold 65% stocks and 35% bonds.

Aggressive funds generally hold significantly more stocks than bonds. This tends to make them high-risk, high-reward investments with the potential for a lot of growth and a lot of loss.

Target-Date Funds

An investor chooses a year that’s closest to the end of their investment objective when they buy into a target-date fund. The asset allocation of the fund shifts over time in relation to the target date.

The funds will initially take a high-risk, high-reward investment strategy, allocating as much as 90% of assets to stocks. This increases the likelihood of early growth.

The asset allocation automatically shifts to become less risky as the target date gets closer. It favors conservative investments such as bonds. This slows the growth of the investment, but it also keeps your money safer.

Target-date funds are often used for long-term financial planning, such as retirement or educational savings accounts. The target date you select might be the year you plan to retire or send a child to school. The shift in asset allocation means that your investment becomes more conservative as you get closer to using the money, to minimize the risk of loss.

Some 401(k) plans use target-date funds as their default for plan participants who don’t select their investments.

Do I Need Hybrid Funds?

Hybrid funds are a good choice for many investors. They allow you to diversify with just one mutual fund. Beginners can use hybrid funds to get started investing, or they can use them as a core holding in a portfolio of mutual funds or ETFs.

Hybrid funds come with risks, like all investments. Aggressive balanced funds can experience high growth, but they’re also volatile. Greater stock allocation can make for greater performance in the long run, but the higher relative risk and lower returns in down markets may be too volatile for investors with lower risk tolerance.

A financial planner can help you identify your goals if you’re unsure whether hybrid funds are a good choice for you. They can assess your risk tolerance and guide you to the right investments.