What Are Fixed Income Funds?
Fixed income funds are mutual funds that invest in high quality fixed income securities like government debts, treasury bills, money markets, etc. and pay the investors a fixed rate of return as per the payment terms and period. The payment schedule could be either monthly, quarterly or yearly basis based on the initial terms of agreement.
These kinds of funds are very useful for investors who are looking for a stable and regular return. Usually, investors who wish to invest on a medium to long-term basis go for such funds. The main aim to reduce risk and cater to a wide range of investor needs and generate wealth.
Table of contents
- Fixed income funds are mutual funds that invest in high-quality fixed income assets such as government loans, treasury bills, and money markets.
- They offer investors a fixed rate of return based on the payment terms and duration, which can be monthly, quarterly, or yearly.
- Investors in fixed income funds can benefit from tax exemptions on dividend income up to a specified amount per fiscal year, similar to other mutual funds. However, the corporation managing the fund is responsible for paying dividend distribution tax on the dividend payouts to investors.
Fixed Income Funds Explained
Fixed income funds are mutual funds that invest on behalf of their clients in instruments such as bonds, treasury bills or other instruments in the money market that provide fixed returns.
Top fixed income funds are always mindful of the investor’s desire for high returns with low risk. This fund collects investors’ amounts and invests in various types of securities like debt instrument, debt & equty instruments, i.e. It diversifies the investor’s fund in a variety of securities in order to mitigate risk and provide handsome returns to the investor. Investors can also shuffle the funds according to their preferences. Although the expense of mixing funds is incurred, an investor still has the right to select suitable securities and receive a higher return.
Thus, the returns on this type of investment option are known beforehand and do not change. Unlike equity, the return will totally depend on the market condition. A massive benefit for fixed-income investors is that if the company issuing the funds goes bankrupt or shuts down operations, they are paid their dues before the equity holders.
Best fixed income funds help corporate houses and the government raise a large amount of money to run their daily operations and meet financial needs. However, at maturity, investors get fixed income funds returns and return the initially invested amount or the principal.
Mutual fund companies curate different funds for clients with different interest, time frames, and risk appetites. Let us understand the different types of global fixed income funds which will help understand the concept in depth.
#1 – Debt Fund
Debt fundDebt FundDebt fund are investments, such as a mutual fund, closed-end fund, ETF, or unit investment trust (UTI), that primarily invest in fixed-income instruments like bonds or other types of a debt security for returns. is a fund that invests the investor’s amount in various financial instruments, which gives a fixed return. For example, it can be corporate bondsCorporate BondCorporate Bonds are fixed-income securities issued by companies that promise periodic fixed payments. These fixed payments are broken down into two parts: the coupon and the notional or face value., DebenturesDebenturesDebentures refer to long-term debt instruments issued by a government or corporation to meet its financial requirements. In return, investors are compensated with an interest income for being a creditor to the issuer., and government securities. This fund has a meager risk because money does not get invested in the Stock MarketStock MarketStock Market works on the basic principle of matching supply and demand through an auction process where investors are willing to pay a certain amount for an asset, and they are willing to sell off something they have at a specific price., and investors receive interest amounts at regular intervals.
Common types of debt funds include:
- Monthly Income Plan: In this, some part of the amount is invested in a Debt instrumentDebt InstrumentDebt instruments provide finance for the company's growth, investments, and future planning and agree to repay the same within the stipulated time. Long-term instruments include debentures, bonds, GDRs from foreign investors. Short-term instruments include working capital loans, short-term loans., and some is invested in equity. So, the mixture of investment in both instruments provide good returns monthly, quarterly, half-yearly, or yearly.
- General Debt Funds: General debt fund is a fund that invests the amount in different debt instruments. It can be invested in debt instruments of both government and private organizations.
#2 – Exchange Traded Funds
Exchange-Traded fundsExchange-Traded FundsAn exchange-traded fund (ETF) is a security that contains many types of securities such as bonds, stocks, commodities, and so on, and that trades on the exchange like a stock, with the price fluctuating many times throughout the day when the exchange-traded fund is bought and sold on the exchange. are index funds that refer to the indices of the stock market. This fund is a combination of various stocks traded on the stock exchange. It is called an exchange traded fund because it is traded on the stock exchange. In this fund, the risk is slightly lower than the risk if invested in a specific share because this fund invests in a basket of securities.
#3 – Money Market Fund
Money MarketMoney MarketThe money market is a financial market wherein short-term assets and open-ended funds are traded between institutions and traders. funds invest only in the money market like commercial paperCommercial PaperCommercial Paper is a money market instrument that is used to obtain short-term funding and is often issued by investment-grade banks and corporations in the form of a promissory note., treasury billsTreasury BillsTreasury Bills (T-Bills) are investment vehicles that allow investors to lend money to the government., and other cash equivalent securities. It is a type of Mutual fundMutual FundA mutual fund is a professionally managed investment product in which a pool of money from a group of investors is invested across assets such as equities, bonds, etc which invests in high-quality, short-term funds. Therefore, money market fund investment risks are extremely low, and investors receive good returns.
Top fixed income funds have various ranges of funds for their clients. However, common traits of these funds are the deciding factors to feature in this list. Let us understand the features through the discussion below.
- Provide Fixed Income at Regular Intervals: These funds provide fixed income at regular intervals, such as monthly, quarterly, yearly, after diversification of the investors’ fund and supply a steady source of income to investors.
- Higher Return than Saving Bank Account: On average, these fixed income funds returns are higher than the saving bank interest rate, which is approximately 3.5% to 4%. Although some risk exists in investment in Fixed IncomeInvestment In Fixed IncomeFixed income investment is a type of investment in which the investor receives a fixed and relatively stable stream of income in the form of dividends or interest over a period of time. Companies and governments typically issue fixed investments in the form of debt securities. funds, it gives more returns.
- Tax Implications: If investors invest in these funds like any mutual fund and such fund provides any dividend income, such income is is exempt Is ExemptExempt income refers to certain sources of income earned by an individual that are not taxed under the revenue laws of the country or the state laws, and thus do not form part of the total taxable income. in the investors’ hands up to a certain amount in a financial year. However, the company pays dividend distribution tax on the dividend distribution to investors who are investing in fixed income funds.
Let us understand the concept of global fixed income funds with the help of a couple of examples.
Eric a retired marine veteran wanted to invest his pension and his modest savings into schemes or funds that gave him fixed returns and the risk involved in the process to be minimal.
Upon conversing with one of his neighbours, who was a financial advisor, suggested to invest into a couple of top fixed income funds. As a result, his money was invested systematically into funds that invested into treasury bills and bonds.
With virtually no risk of losing money, Eric began receiving fixed income from his investments and was stress-free because of the nature of the investment.
Top Five Fixed Income Funds (US)
Some of the top such funds available in the US market are as follows –
- Wisdom Tree Floating rate Treasury Fund
- Vanguard Emerging Markets Government Bond ETF
- Vanguard Federal Money Market Fund
- iShares 1-3 Year Treasury Bond ETF
- Vanguard Intermediate-Term Investment-Grade Fund Admiral Shares
Source – https://money.usnews.com/investing/funds/articles/best-fixed-income-funds-to-buy
Apart from being one of the safest forms of investments, there are a significant number of advantages of investing in global fixed income funds. Let us understand them through the discussion below.
- Diversification of fund:- If an investor invests in the fixed income fund, it diversifies the investors’ fund in various portfolios and provides fixed income at regular intervals.
- Investment after researching various funds:– In these funds, the amount is invested after researching different funds in which portfolio amount should be invested so that there will be low risk and more returns.
- Change in the portfolio if required:– Investors can change the portfolio according to their own choice. An investor can sell the longer-duration funds and buy lower-duration funds.
- Stable income – Fixed income funds returns
- provide a stable level of capital appreciation after certain years. Debt funds , that include debentures and bonds, pay a fixed interest.
- Low Risk – Since the returnsa re not directly linked to the equity markets, the risk and volatility is very low.
- Liquid – The liquidity factor is present in investing in fixed income funds because the funds can be redeemed at any time and the redemption amount is deposited in the investor’s bank account in T+3 days.
Despite the various advantages as discussed above, there are a few disadvantages of investing in such income funds which must be discussed to fully understand the concept.
- It provides a low return in comparison to equity investments. Since Equity InvestmentsEquity InvestmentsEquity investment is the amount pooled in by the investors in the shares of the companies listed on the stock exchange for trading. The shareholders make gain from such holdings in the form of returns or increase in stock value. hold a lot of risk, it gives a very high return. However, a low risk exists in a fixed-income fund compared to an equity instrument, providing a short recovery.
- Some funds focus only on growth, and they do not pay to investors frequently. Instead, they invest their earnings into the fund so that their fund’s net asset value (NAVNAVNet Asset Value is calculated by subtracting the total value of the entity's liabilities from the total value of its assets and dividing the result by the total number of outstanding shares.) increases and gives more money to the investor on the maturity date. Thus, the investor will not get interest or dividend on a monthly, quarterly, half-yearly, or yearly basis, but they will reach maturity with more profit on the maturity date. This mechanism is also called “wealth creation of the fund.”
Fixed Income Funds Vs Money Market Funds
The above are two different types of investment opportunities. But they have some differences. Let us understand the differences between them.
- The former refers to investments that provide fixed-income funds returns to the investor for a particular period, but the latter relates to short-term borrowing and lending.
- The liquidity of the former is less compared to the latter.
- The value of the former fluctuate depending on factors like interest rates, credit quality, etc but the value of the latter is relatively stable.
- The former is for long term investments and the latter is for short term investments.
- The former offers to fund long term projects of local and state governments but the latter offers to manage short term capital needs and serves as a temporary opportunity to keep the money and earn return.
Thus, the above points highlight the differences between them and the choice between the two depends on the financial goals, time horizon and the level of risk tolerance of the investor.
Frequently Asked Questions (FAQs)
Government fixed-income securities, such as U.S. Treasury bonds, are considered secure investments as the government backs them. However, corporate bonds carry a higher risk of default depending on the financial stability of the issuing company.
Not all mutual funds provide fixed income. Debt mutual funds specifically invest in debt and money market instruments like commercial papers, debentures, T-bills, and government securities. These instruments generate interest income for investors and return the principal upon maturity.
Fixed income funds are exposed to various risks due to market volatility. These risks include interest rate risk, reinvestment risk, call/prepayment risk, credit risk, inflation risk, liquidity risk, exchange rate risk, volatility risk, political risk, event risk, and sector risk. Investors should carefully assess and understand these risks before investing.
This has been a guide to what are Fixed Income Funds. We explain their types, with examples, differences with money market funds, features & advantages. You may learn more about Financing from the following articles –