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There are several investment schemes to cater to various categories of individuals. However, such a wide variety also tends to confuse potential investors.
One such popular investment plan includes income funds. Successful investing demands a well-researched and thorough approach to avoid potential pitfalls.
This is why individuals willing to opt for this investment mode must first have detailed knowledge on how they work and things to consider before allocating funds.
Income funds can be termed an investment vehicle similar to an exchange-traded fund (ETF) or a mutual fund. It emphasises the current income compared to capital appreciation or gain. They are a kind of debt mutual fund.
SEBI classifies income funds as those debt funds having a Macaulay Duration of four years and more.
ULIPs also provide income funds. These are managed with well-defined guidelines and controls on which a fund manager can and cannot invest, although this varies across MFs and insurers.
A fund manager invests in fixed income instruments having established financial track records and high credit ratings. Such organisations have lesser default risk in repayment of interest and capital.
An income fund’s NAV is calculated up to four decimal points. The fund manager endeavours to provide great returns irrespective of the interest rate regime. This implies that these funds attempt to deliver returns regardless of the increase or decrease of interest rates. This is done through the active management of an investment portfolio.
Fund managers follow either of the two broad strategies mentioned below -
A glance through an income fund’s historical performance reveals that they tend to outperform the returns delivered by traditional bank deposits while providing more liquidity and flexibility.
Income funds are ideal for investors seeking a stable and regular income. This fund category carries a low risk concerning default.
For example, retired individuals will require funds for meeting their daily expenditures. They will prefer income funds compared to all other fund types. Conservative individuals willing to earn better returns compared to their conventional havens might also consider income funds.
Even individuals with greater risk appetites who prefer investing through equities or equity funds can look forward to investing a part of money in income funds for diversification purposes.
The primary aspect of the differentiation of income funds relates to what a fund is particularly investing in. The various kinds of income funds include the following:
An equity-income fund is an income fund category that invests in dividend-paying stocks from companies. It targets individuals who prefer receiving anticipated monthly income from their dividend-paying portfolio.
Bond funds are an income fund category that specialises in government and corporate bond investments. Investors prefer government bonds because they come with practically no risk. Additionally, they act as a haven for investors seeking a safe option. Owing to risk reduction, such bond types provide lesser dividend yields than corporate bonds.
REIT or real estate investment trust is a legal entity that owns real estate investments, like commercial office buildings, retail locations, hotels, and housing.
The primary benefit of a REIT income fund is realising the advantages of real estate ownership without actually owning and maintaining a property.
Money market funds are a kind of income fund that invests in certificates of deposit (CDs), short-term treasury bills, and commercial papers. Though money market funds do not carry federal deposit insurance coverage like most bank products, they offer an extremely safe option to investors through lesser yield rates.
The primary aspect of the differentiation of income funds relates to what a fund is particularly investing in. The various kinds of income funds include the following:
An equity-income fund is an income fund category that invests in dividend-paying stocks from companies. It targets individuals who prefer receiving anticipated monthly income from their dividend-paying portfolio.
Bond funds are an income fund category that specialises in government and corporate bond investments. Investors prefer government bonds because they come with practically no risk. Additionally, they act as a haven for investors seeking a safe option. Owing to risk reduction, such bond types provide lesser dividend yields than corporate bonds.
REIT or real estate investment trust is a legal entity that owns real estate investments, like commercial office buildings, retail locations, hotels, and housing.
The primary benefit of a REIT income fund is realising the advantages of real estate ownership without actually owning and maintaining a property.
Money market funds are a kind of income fund that invests in certificates of deposit (CDs), short-term treasury bills, and commercial papers. Though money market funds do not carry federal deposit insurance coverage like most bank products, they offer an extremely safe option to investors through lesser yield rates.
The various income fund benefits are illustrated as follows -
Individuals willing to invest in income funds should consider the below-mentioned factors:
Income funds carry both interest rate risk and credit risk. Following is an illustration of both these risk types:
An interest rate change may result in a change in the bond price value that will affect the fund value. Furthermore, the risk of a bond issuer defaulting on processing a promised payment is always present. This may cause an impact on the fund returns. Additionally, the fund manager may invest in securities of lower credit rating for producing higher returns, thereby raising the overall portfolio risk.
Income funds can be an excellent way of making greater returns by taking advantage of the volatile interest rates. Instead of allocating funds in a regular bank FD, investors may consider income funds as an efficient alternative. However, given that there are no guaranteed returns in income funds, they should be prepared to bear the additional risk.
Income funds charge an amount as a fee for managing an investor’s funds. This fee is termed as an expense ratio. Considering the lower returns produced by these funds compared to equity funds, a long-term holding period will help recover the funds gone out by way of the expense ratio.
Individuals with an investment horizon of one to three years may consider these funds for investing their short-term surplus funds. Investors must time their entry and exit properly for getting the maximum out of these funds.
A suitable time for entering will be at lower interest rates. Similarly, an ideal time to exit will be as the interest rates start increasing. If an individual plans to allocate money in long-term FDs, income funds will be a better alternative.
The applicable tax rate for income funds is the same as that for debt funds. Therefore, for an investor in the 20% and above slab rates, the LTCG will face taxation at 20%. However, in such a scenario, indexation benefit is allowed.
Generally, individuals choose a fund that delivers the highest returns. Besides examining the expense ratio, it is imperative to conduct background research on the fund house.
This includes the duration for which a fund house has been operating, the history of fund managers, etc.
Income funds invest in securities generating high income that are ideal for supplementing an investor’s current income. Retirees may invest in these funds to receive additional money besides their regular pension.
These funds can prove to be highly helpful for individuals having a short-term goal of funding their EMI or planning for higher education. Income funds are highly flexible as they offer options like STP, SWP and SIP.
Individuals must keep in mind the above mentioned aspects related to income funds. These would be ideal for those planning about retirement, child's education, keeping aside funds for a down payment, or having other long-term goals.
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Disclaimer: This information is added only for informative purposes and collected from different sources across the Internet. Digit Insurance is not promoting or recommending anything here. Please verify the information before making any decisions.
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