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As stock markets have dropped over the past year, many investors have discovered that they don't like risk as much as they thought when stocks were going up. After suffering scary losses in their portfolios, they naturally want to find safer investments.

Of course, if you're only now starting to think about cutting your stock exposure in your portfolio, your timing couldn't be worse. The S&P 500 recently hit two-year lows, and stocks worldwide have taken similar or worse hits. Meanwhile, those safer assets you're thinking about -- bonds and cash -- are expensive, as low yields on Treasuries aren't even keeping up with inflation. Even dividend-paying stocks haven't been immune, as financially strapped companies like Wachovia (NYSE: WB  ) continue to tighten their belts and cut dividends.

Instead of getting rid of stocks entirely, a reasonable compromise is to look at certain mutual funds known as balanced funds. Although balanced funds maintain a healthy allocation to stocks, they also include less volatile alternatives that together help to smooth the ride for investors like you.

Keeping your balance
This month's issue of the Fool's Champion Funds newsletter -- which goes live at 4 p.m. ET this afternoon -- takes a look at a couple of promising balanced funds that may interest you if you're looking to tone down your portfolio's risk level. But before talking about them specifically, let's take a moment to get you up to speed on balanced funds generally.

The typical balanced fund combines two different asset classes -- stocks and bonds -- within a single fund. The exact proportion of stocks and bonds varies from fund to fund; some funds go with a 50/50 approach, while others have a slightly higher allocation to stocks. Regardless of the exact allocation, however, balanced funds have two goals: to dampen price movements compared to funds invested 100% in stocks, and to pay out more income than stock funds can typically provide.

Different ways to crack an egg
How balanced fund money managers achieve those goals, however, differs widely among funds. The Vanguard Balanced Index Fund (VBINX), for instance, splits its assets 60/40 between stocks and bonds. It then uses an index strategy to track a broad-market stock index and the Lehman Aggregate Bond Index. As a result, you'll find three different Treasury securities among its top 10 holdings, as well as stocks like Procter & Gamble (NYSE: PG  ) , Johnson & Johnson (NYSE: JNJ  ) , and Chevron (NYSE: CVX  ) .

On the other hand, some balanced funds use an active-management approach to seek out the best investments in both the stock and bond arenas. One of the funds that Champion Funds lead advisor Amanda Kish discusses is the Dodge & Cox Balanced Fund (DODBX), whose impressive 10-year return of 8.2% puts it in the top 3% of all moderate-allocation funds, according to Morningstar. It allocates money 70% to stocks and 30% to bonds. Although a big helping of financial stocks has hurt its performance recently, holdings like Comcast (Nasdaq: CMCSA  ) , Wal-Mart (NYSE: WMT  ) , and Amgen (Nasdaq: AMGN  ) have helped limit the fund's losses.

Balanced funds will never light up the charts with stellar performance, even when the stock market is up sharply. But that's not what they're designed for. Instead, the ideal balanced fund delivers a consistent string of reasonable returns year after year, making the tough years for the markets a little easier to get through. For conservative investors, that's the ticket to a great long-term investment.

To find out about the second balanced fund that Amanda's looking at right now -- as well the reasons why she's not quite ready to pull the trigger and buy -- take a look at the newest issue of Champion Funds. It's a subscription service, but a 30-day trial costs you nothing and gives you full access to current and past issues, as well as other useful resources for fund investors. With no obligation to subscribe, you have nothing to lose and everything to gain.

Fool contributor Dan Caplinger has some balance in his portfolio, but he doesn't own shares of the funds and stocks mentioned in this article. Wal-Mart is a Motley Fool Inside Value recommendation. Johnson & Johnson is a Motley Fool Income Investor pick. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy pays dividends.

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