What is an Income Fund?
An income fund is an investment vehicle similar to a mutual fund or an exchange-traded fund (ETF) that emphasizes current income compared to capital gain or appreciation. The term current income refers to income that is received on a fixed basis compared to waiting for some future date in order to receive the financial payout. For example, income fund compensation is commonly awarded on a monthly or quarterly basis.
Usually organized through financial institutions, income funds consist of preferred stock, dividend-paying stocks, bonds, and government/corporate debt obligations. Such funds are considered a low-risk option for investors because they typically hold stocks with a fair history of paying dividends.
Due to the low-risk and fixed nature of income funds, they are popular among individuals who would like to create an additional income stream for when they retire.
Types of Income Funds
When it comes to the deviation of income funds, the primary aspect of differentiation relates to what the fund is specifically investing in. The types of income funds include:
1. Bond Funds
As the name suggests, bond funds are a type of income fund specializing in corporate and government bond investments. Investors are attracted to government bonds because they hold practically no risk and act as a safe haven for individuals looking for a safe option. Due to risk reduction, such types of bonds offer lower dividend yields compared to corporate bonds.
As for corporate bonds, investors are attracted to them because they offer higher yields to make up for the additional risk that is given to the investor.
2. Equity Income Funds
An equity income fund is a type of income fund that invests in dividend-paying stocks from organizations. It is aimed at investors who would like to receive anticipated monthly income from their dividend-paying portfolio.
3. Money Market Funds
A money market fund is a form of an income fund that invests in commercial papers, short-term Treasury bills, and certificates of deposit (CDs).
Although they do not carry federal deposit insurance coverage as most bank products do, money market funds provide a very safe option to investors through lower yield rates.
4. Real Estate Investment Trusts (REITs)
A real estate investment trust (REIT) is a legal entity that owns real estate investments, such as housing, commercial office buildings, retail locations, and hotels.
The primary advantage of a REIT income fund is to realize the advantages of real estate ownership without actually having to own and maintain the property.
Advantages of Income Funds
Apart from potential risk aversion, there are a large number of benefits that income funds provide to investors, including:
Diversification: When an individual invests in income funds, they provide an assortment of specific asset classes that allow investors to diversify their portfolio extensively.
Expense Ratios: Most income funds offer low expense ratios, allowing investors to increase their net earnings on investments.
Simplified Investing: Income funds are simple to manage because individuals can determine their monthly budget quite easily and receive regular payments.
If you are looking for a safe investment that does not require a lot of management or financial knowledge, then investing in an income fund may be a viable option.
Disadvantages of Income Funds
In a financial world that offers many options for investors, income funds may not be the first choice. Shown below are the disadvantages of income funds compared to other financial instruments:
Risk Assumption: A common misconception is that income funds are 100% risk-free. It is not the case, however. Some forms of income funds, such as equity income funds, actually carry a degree of risk and should be studied thoroughly before a decision is made.
Performance Measurement: In most cases, income funds are not able to measure performance effectively. Especially dividends, the yield that is realized may overlook actual financial gain.
Although minimal, the disadvantages of an income fund may deter potential investments. It is beneficial first to be aware of the potential downsides of a specific financial instrument.
Investing in Income Funds
When investing in any financial instrument, it is crucial to be aware of the characteristics that can either increase or decrease your financial gain.
When investing in an income fund, it is critical to research and consider the following:
- The income funds expense ratio to measure profitability
- Which type of income fund is the best for your situation and future goals
- The previous historical performance of the income fund you are interested in
- The management of the income fund with regards to payment intervals and income schedule
Becoming more educated on some of the characteristics above will yield a much smarter and more profitable endeavor that will help investors achieve their desired outcome.
CFI offers the Capital Markets & Securities Analyst (CMSA)® certification program for those looking to take their careers to the next level. To keep learning and advance your career, the following resources will be helpful: