Investing is one of the most lucrative ways to create another cash flow without breaking your back. However, investing is tricky and has its ups and downs due to the volatile nature of the market. An exchange-traded fund (ETF) is a type of fund that holds several profitable assets rather than only one. Income funds are a type of ETF or mutual fund that increase current income in periodic intervals.
Income funds hold a variety of fixed-income securities like government and corporate bonds, dividend-paying stocks (a company’s profit share that is paid to its shareholders), and money market instruments (liquid instruments that provide fixed returns with a maturity turnover of less than a year). They do not focus on helping you earn money from selling off your investment at a higher price. Rather, they help you earn a consistent income from your investments.
Money market mutual funds (MMMFs) are intended for investors looking to park their cash or cash equivalent assets for a short period. They include treasury bills, banker’s acceptance, and certificates of deposit that financial institutions like banks use to raise money for the short term. Though not as safe as cash, they are considered comparatively lower risk than other options. The biggest advantage of investing in these income funds is their liquidity. You can sell them anytime as there is no fixed investment period. However, they are not suitable for long-term investments.
Who Should Invest in Income Funds?
Income fund investment yields return by compounding over a certain period. The change in interest rates and the investment period considerably affects its gains. This makes income funds a suitable option for those willing to take high risks and those just looking to amplify their retirement income. Income funds, as the name suggests, help generate income from investments. People with a regular income prefer income funds as a viable retirement option. Income funds are more of an added source of income for some.
Benefits of Investing in Income Funds
For all the right reasons, income funds have emerged as a popular choice among investors. Some benefits of investing in income funds are as follows:
· Lower Risk
There is a considerable risk in every form of investment. If you invest in income funds, you will lose some money if the credit rating goes down or the interest rates drop. However, income funds invest in a combination of bond funds and equity funds. There is a higher risk component in equity income funds. Government bonds or corporate bonds with high credit ratings are one of the most secure forms of investment. They carry a sovereign guarantee, meaning the issuing body is liable to repay the money as per the stipulated terms since the government issued them.
· High Liquidity
Unlike fixed-income instruments, income funds can also be invested in the short term. However, you will see better returns in a longer investment period. The fund managers actively look for opportunities to sell income funds and optimise the returns. In such scenarios, income funds generate a higher profit than bank deposits.
· Better Returns over a Longer Period
Since income funds generate lower returns than equity funds, it is recommended that you lock in the money for a longer period. A longer investment period generates a much higher return. However, income funds allow you to choose your desired investment period.
· Tax Benefit
Unlike bank fixed deposits, debt bonds are not taxed every year. If you are in the highest tax bracket, you will save some money on tax as long-term capital gains up to Rs. 1 Lakh are tax-free. If equities are sold before a year, and the capital gain is more than 1 lakh rupees, you will be taxed 15% plus 4% cess.
Income fund managers invest in a variety of fixed-income instruments. Some of these, like government bonds, cannot be purchased by retail investors. You will need the help of fund managers, who act as a medium to issue these bonds. A diversified portfolio lowers the market risk significantly.
Fees and Charges of Income Funds
Fund houses charge a small percentage of money from your investments to pay their employees and cover other investor purchases, redemption charges, and exchange costs. These are called ‘Shareholder fees’ and are always mentioned in the fund’s prospectus. But, most fund houses have their assets to take care of their expenses. While they do not charge investors directly for this, you will pay a certain portion of this money under the section ‘Annual Fund Operating Expenses.’
‘Annual Fund Operating Expenses’ cover management costs, distribution charges, and other expenses. Different fund houses charge different amounts of money. The expense ratio may seem like a small percentage of money at the beginning, but over time, the compound interest effect will take away a significant portion of your profits. You can directly invest in mutual funds through online investment platforms if you do not want to pay for these commissions.
Working of Income Funds
An income fund is an asset allocation fund that provides income from investments. Fund managers invest in companies that return their profits in cash to the issuer. It is different from growth funds in the respect that growth funds re-invest the generated profits to grow their pool of capital. Even so, the accumulated funds in income funds generate returns due to the compounding effect over an investment period.
The value of income funds is regulated by interest rates and credit ratings. The share prices of income funds fall when interest rates rise and vice versa. When choosing income funds, you should focus on investment-grade income funds. Investment-grade ratings are a system of qualifiers that determine whether a bond is at low risk of default. These credit ratings express a futuristic outlook on an entity’s capability to meet its financial commitments as and when they are due. AAA is the highest credit rating that can be assigned to an issuer’s bonds.
Income funds are popular mutual funds that can generate consistent monthly revenue for their investors. However, it maximises the current income. It is subject to interest rate and market risk. The two key factors that you must zero in on are the risk level and expense ratio of a fund. While it may be tempting to only invest in the funds that have generated maximum returns in the past few years, you must evaluate how long the company has been functional and compare its returns in the last 10 years. Income funds are not known for building wealth. But, income funds with an investment period of over 10 years generate considerable returns.
Are income funds better than individual stocks?
If you do not have the luxury of time and knowledge to analyse daily market fluctuations, it is better to invest in income funds for a supplementary income source later in life. Income funds generate good profits over a longer investment period. Hence, they also carry minimal risk.
Can I lose money in income funds?
Like every other investment, income fundsare also subject to interest rates and market risk. If credit ratings interest rates fall, the value of an equity fund or corporate bond will also suffer. However, it is quite unlikely that you will lose all your money.
How many types of income funds are there?
There are two kinds of bond funds: government and corporate. Government funds carry no individual risk and are the safest choice for investors in times of crisis. Comparatively, corporate bonds carry a threat of the issuer being unable to pay the principal amount and are subject to some market risks.
Are credit ratings important for income funds?
Credit ratings are important in the buying of income funds because they present a transparent outlook and help the market participants function smoothly. It is a common grading system for different levels of creditworthiness of income funds that does away with complicated jargon and makes it easier for smart investors.
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