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Income Funds

Updated on May 30, 2024
Article byNiti Gupta
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

What are Income Funds?

Income funds are those funds that provide the investors with regular income in the form of interest or dividends by way of making investments in government bonds, corporate bonds, high dividend earning stocks and other securities yielding high interest and dividend incomes.

Key Takeaways

  • Income funds invest in government bonds, corporate bonds, high dividend-paying companies, and other securities that generate high interest and dividend incomes. They aim to provide investors with regular income through interest or dividends.
  • Income funds achieve this by holding the investments until maturity to earn earnings or selling the investments if their prices increase to generate gains.
  • Bond funds invest in both government and corporate bonds. Government bonds are considered relatively safer as they carry no default risk but may have lower returns than other investments.

How Does it Work?

Income funds take initiatives to deliver good returns, whether the interest rate declines or increases. They do so by attempting to earn incomes by holding the investments until maturity. Alternatively, they try to make gains by disposing of the investments if the price of such investments increases. The value of the fund may be determined by way of Net Asset Value (NAV). These funds diversify their investments by investing both in stocks as well as bonds. Generally, when the value of the inventory decreases, the amount of bonds goes up and vice-versa.

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Example

A fund has a total asset value of $20 billion as of 31st March 2019, and the fund makes investments in high dividend-paying stocks. The fund makes quarterly payout in dividends at the rate of 10% to its investors.

Income Funds

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Types

The income funds may come in different forms. The investors may choose the fund based on their requirements and the features of the fund. There are four types –

Types of Income Funds

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#1 – Money Market Funds

Such funds are considered to be very safe, and also the return provided by these funds is lower. Money market funds invest in certificates of deposits, short-term treasury bills, and commercial papers. The prices of funds do not face significant changes.

#2 – Bond Funds

Bond funds are those funds that make their investments in government as well as corporate bonds. As far as government bonds are concerned, there is no risk involved and thus are relatively safer. But the returns are also limited for government bonds. Corporate bonds carry a certain degree of risk, and as a result, a high rate of interest is offered by such funds.

#3 – Equity Funds

These funds make investments in stocks of such companies which pay regular incomes in the form of dividends. Investors who are in the age group of retirement usually prefer these income funds since they can get a predictable amount of income periodically.

#4 – Other Income Funds

The investments made by other funds may include investment in REIT bonds, MLPs, and other similar products.

How to Determine Income Funds?

One can determine whether a particular fund is an income fund or not by looking for the following features in the fund.

  • Such funds involve a low level of risk. This is because the fund managers make investments in safe options such as government and corporate bonds of companies having good credit ratings.
  • Such funds are very liquid as compared to other fixed-income instruments. Moreover, they are not subject to high lock-in-periods.
  • They can provide better returns as compared to debt instruments. This is because the fund purchases the debt instruments in bulk and is in a better position for negotiation.
  • In addition to this, these funds are subject to credit risk and interest rate risk.

Advantages

  • Income funds are comparatively more liquid than fixed income instruments, such as fixed deposits.
  • The funds are actively managed and intend to provide returns in declining as well as increasing interest rates.
  • The rate of returns earned on such funds is higher than fixed income instruments.
  • There is a high degree of flexibility in such funds as the investors can withdraw money and maintain their cash flows.
  • It may provide monthly income cash flows, which may be useful for investors majorly, such investors who are of retirement age.

Disadvantages

  • They are subject to interest rate risk as well as credit risk. Interest rate risk is the risk that the interest rate will increase, and as a result, the value of underlying bonds will fall. Credit risk refers to the risk of non-payment of incomes by the issuer of bonds.
  • In some income funds, payouts are not guaranteed as the fund managers may reinvest the earnings into the fund instead of making payouts.
  • There are management charges and other fund related charges, the burden of which is borne by the investors ultimately.

Conclusion

Income Funds are great investment options for those investors who are unwilling to take many risks and are looking for safe investment options. Such funds provide the investors with periodic returns and are comparatively safer too.

Frequently Asked Questions (FAQs)

1. Is an income fund a good investment?

Income funds are generally considered low-risk for investors, as they often include stocks with a track record of delivering dividends. These funds are favored by those seeking to establish an additional income stream for retirement due to their low-risk and fixed nature.

2. What are the risks associated with income funds?

Two main risks are associated with fixed-income investing: interest-rate and credit risk. Typically, when interest rates rise, the market value of bonds decreases. Credit risk refers to the possibility that the bond issuer cannot make principal and interest payments.

3. Which is better, growth or income funds?

The choice between growth and income funds depends on an investor’s individual financial goals and risk tolerance. Growth funds aim for capital appreciation by investing in companies with high growth potential, while income funds focus on generating regular income through dividends and interest. Growth funds may be more suitable if an investor seeks long-term wealth accumulation. On the other hand, if an investor prioritizes current income and lower volatility, income funds could be a better fit.

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