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Income Funds

Income Funds are classified under the debt mutual funds category and serve as a steady source of income for investors. The diversification of funds benefits investors by enabling them to invest in equities as well as bonds. Further, it allows investing in multiple asset classes like Certificates of Deposits (CD), money market instruments, government securities and corporate bonds, prioritising assets with higher rates of interest. The high dividends generated can either be invested or distributed among the investors.

Types of Income Funds

Professional fund managers have the expertise required to efficiently manage income fund portfolios based on the movements and fluctuations in interest rates, which need to be closely monitored to achieve optimum investment benefits. Professional fund managers have the expertise to evaluate market situations and manage the portfolio accordingly, irrespective of rising or falling interest rates. The end goal is to generate healthy returns on investments. The returns can be in the form of interest income generated by holding on to the income fund instruments till it reaches its maturity or enjoy capital gains by selling them in the debt market at the right time. This implies that, unlike Fixed Deposits, income funds do not promise fixed returns. However, contrary to deposits, they have generated higher returns than 3-year Fixed Deposit rates in the last decade.

Let’s have a look at the leading income fund categories and their unique features, customised to suit varied risk appetites. Bond Funds: Issued by government entities or corporations, these generate a certain amount of interest annually, which acts as an income for the investor. A bond fund consists of debt instruments like bonds and mortgage-backed securities.

High-yield Bond Funds

Comparatively riskier than bonds, they are issued by investment-grade companies with high ratings. As a result, they often offer higher yields.

Global Bond Funds

Global bond funds invest in an extensive variety of bonds issued by different public and private entities across the world. This includes those issued by governments, local authorities, international bodies and private corporations.

Equity Income Funds

Equity income funds involve buying stock ownership or equity schemes of companies. The objective of equity income funds is to aim for capital appreciation after the value of the stocks in the fund increases. Further, it may also aim at income generation from stocks that pay dividends.

Hybrid or Multi-Asset Funds

Hybrid or multi-asset funds often involve investing in a number of traditional equity and fixed income strategies, financial derivatives and index-tracking funds. Besides, it also targets alternative investments like REIT (Real Estate Investment Trusts) and commodities.

Advantages of Income Funds

Income funds are a smart investment instrument for investors across ages. It may serve as an alternative source of income for earning individuals, act as financial support during unforeseen emergencies or may prove to be an effective retirement plan. Here’s why they are beneficial for investors of varied investment goals:

Better returns than traditional FDs

Income funds have generated higher returns than 3-year Fixed Deposits in the last decade. You may want to make the most of the benefits of both Income Funds and FDs by investing in a combination of both. In the year 2010, the CAGR for deposits was recorded at 9.5%, while CAGR for income funds was 9.5%. However, the post-tax CAGR for deposit was 6.6% and post-tax CAGR for income funds was 8.4%, recording higher returns by 1.8%.

Lower re-investment risks

Re-investing income funds in multiple interest rate cycles guarantees higher returns. This is in contrast to fixed deposits that attract lower rates of interest when re-invested after reaching the maturity tenure, offering lower returns.

Ensure Liquidity

Income funds enable investors to withdraw money as per their convenience, which is not the case with traditional fixed deposits as they are accompanied by a fixed lock-in period.

Flexible Investment Instrument

Apart from ensuring liquidity, it also offers a systematic withdrawal feature. Opting for this benefit will enable you to withdraw cash at systematic intervals, acting as a regular and steady source of income.

Attracts tax benefits

Income funds are accompanied by long-term capital gains after being held for a year and are taxed either at the rate of 10% without indexation, or 20% with indexation. It generates the maximum returns for people in 20% and 30% tax brackets. On the other hand, interest on fixed deposits is taxed as per your income slab.

How do Income Funds work?

Income funds aim to generate returns during increasing and decreasing rates of interest. Efficient management of income funds portfolio involves two different strategies:

  • Generate income in the form of interest on staying invested till the end of the maturity term

  • Selling them when their market prices rise

The following are some salient features of how income funds work:

  • Fund managers keep a close track of the investment market and allocate the assets in the portfolio towards debt and money market instruments, aiming at high returns. They evaluate investments based on their interest rates – the lower the interest rates, the lesser will be the risks involved.

  • What makes income funds score over fixed deposits is that they are not accompanied by lock-in periods, which ensures liquidity. Further, they have been generating higher returns since the last 10 years on staying invested for at least 3 years and more.

  • Based on the holdings, income funds can be regarded as conservative or risky investments. Certain income funds invest only in securities of renowned companies, such that the investor is assured of getting dividends consistently. While some others generate income only through interest payments, emphasising on income fund investments primarily being conservative by nature. However, there are some specific income funds that appeal to investors with a high-risk appetite by investing in instruments like bonds and REIT, which offer higher returns than the conservative funds.

  • Income funds invest in a combination of stocks and bonds, offering instant diversification. The prices of stocks and bonds are negatively correlated, that is, when the prices of bonds rise, the prices of stocks fall and vice versa. Therefore, it is highly recommended that investors invest in both to maintain a healthy balance during unstable capital market conditions, acting as a hedge against market risks. However, the concept of negative correlation has been refuted by some investment experts. They argue that when rates of interest and inflation fall, it challenges the strength of negative correlation, reducing the effectiveness of the hedge.

  • Income funds are synonymous with systematic payments, however, there are certain exceptions to this benefit. These generate special payments whenever possible. Resultantly, you need to read the investment documents carefully and do a thorough research before investing in an income fund.

Things to Consider as an Investor

Interested in investing in income funds? Here’s a list of all that you should consider before you take your investment decisions. Risks involved: The type of holdings determines the degree of risk involved with it. The more the equity percentage, the higher will be the risks. Bond and equity prices are negatively correlated. Therefore, investing in a combination of bonds and stocks is a better alternative as it offers a greater chance of safeguarding you by providing a hedge against market risks.

Check the expected returns

Income funds have been generating higher returns than FDs on staying invested for at least one year. This is because they offer the benefits of compound interest. While assessing the available income fund schemes check for the estimated returns to be assured that you are considering the right schemes.

Investment duration

Like all other debt mutual funds, income funds also offer short, medium and long-term investments. However, income funds offer the unique benefit of short-term investments, as short as just a few days. This gives investors the opportunity to safely keep their money at a short notice. Medium and long-term income funds involve a longer investment horizon.

Tax efficiency

Long-term capital gain (LTCG) is applicable on income funds held for more than 3 years. It is taxable at 10% without indexation or 20% with indexation benefit. The higher the tax slab, the higher will be the returns on income fund investments. Therefore, 30% tax slab generates the best returns as compared to the 20% and 10% tax slabs.

Timing it right

Since income funds generate higher returns on staying invested for a longer term, it is best to sell them after they reach maturity. Purchasing income funds should be done when the interest rates are low. Make sure that you do a comparative analysis of the existing prices of the leading income funds before buying them.

How to Evaluate Income Funds?

Creditworthiness of the Asset Management Company

Word of mouth, and more so the digital platform, challenges Asset Management Companies to be consistent with their quality of services. It is difficult to recover from a loss of reputation.

Fund performance

One of the glaring mistakes that amateur investors tend to make is that they analyse a fund based on their performance in the recent past. However, what matters the most in the decision-making process is to check the number of years since the fund has been operating, its performance across market cycles and the estimated returns in the next few years.

Expertise of the Fund Manager

The skills of your fund manager will determine whether your income fund portfolio is being efficiently managed based on your investment objectives, market conditions and prevailing interest rates.

Calculate the Financial Ratios

There are certain additional expenses involved during income fund investments, like all other mutual fund investments. These can be calculated, even by amateur investors, with some risk assessment tools that are readily available on the websites of Asset Management Companies as well as third-party websites.

Expense Ratio

This refers to the charges levied by fund houses on the returns earned by investors. The expense ratio is capped at a maximum rate of 2.5% of the NAV, as set SEBI regulations. Therefore, do take this into consideration while estimating your returns.

  • Sharpe Ratio: Income funds cannot be devoid of risks. A higher Sharpe ratio implies at the performance or return, despite the risks involved in every unit of the income fund.
  • Information Ratio: This refers to the benchmark return minus the total portfolio return. It assesses the skills of the fund manager in ensuring risk-adjusted returns over and above the benchmark.
  • Standard Deviation: As the term suggests, Standard deviation highlights the percentage by which the returns of the income fund have deviated from the average returns. For instance, if the average return is 14% and the returns of the fund amount to 16%, the deviation has been positive.

Top 10 Income Funds

Let’s look at the leading Income Funds that have been performing consistently, along with their features, risks involved and estimated returns in the near future:

Names of Top 10 Income FundsFeaturesRisk1-Y Return %3-Y Return %5-Y Return %
SBI Regular Savings FundMoney Market FundModerately Low8.289.259.57
Aditya Birla Sun Life Treasury Optimizer FundBanking and PSU FundModerate7.389.169.4
ICICI Prudential Advisor Series – Dynamic Accrual PlanFund of FundsModerate7.278.648.93
ICICI Prudential Banking & PSU Debt FundBanking and PSU Fund Moderate6.848.548.79
Franklin India Corporate Debt FundCorporate Bond FundModerate6.798.528.79
Axis Regular Saver FundConservative Hybrid Fund Moderately High6.788.498.7
HDFC Corporate Bond FundCorporate Bond FundModerately Low6.768.358.5
BNB Paribas Flexi Debt FundDynamic Bond FundModerate6.718.38.22
Kotak Corporate Bond Fund – Standard PlanDynamic Bond FundModerately Low6.358.278.19
BNB Paribas Corporate Bond FundCorporate Bond FundModerate6.318.168.16

FAQs on Income Funds

Are income funds safe?

Most income funds are well suited for investors with low risk appetite as they offer good returns on staying invested for a long-term of at least 3 years or more. However, the returns are not as high as other debt mutual fund investments. Some income funds invest only in securities of reliable and creditworthy companies to generate returns consistently. Some others deliver income only in the form of interest payments. As a result, income funds are often associated with being a conservative investment instrument. Though they are mostly accompanied by low risks, there are certain income funds that are customised to meet high-risk appetites, like corporate bonds, by investing in instruments like junk bonds and REIT, which offer comparatively great returns than its conservative counterparts.

What is regular income fund?

A regular income fund is a type of debt mutual fund that invests in a combination of government securities, corporate bonds, certificates of deposits and money market instruments. When the portfolio is efficiently managed, it generates steady returns during rising and declining interest rate situations.

What are debt income funds?

A debt income fund belongs to the mutual fund category that invests in fixed income instruments like government bonds, corporate bonds, corporate debt securities and money market instruments etc., aiming at achieving capital appreciation. They are also referred to as debt funds and bond funds.

What are monthly income mutual funds?

A monthly income mutual fund is a debt mutual fund scheme that invests a small portion of about 15% to 25% in equity funds to generate a periodic pay-out every month.

What is an income mutual fund?

Income mutual funds aim to generate a periodic income for investors by investing in securities offering returns or interest payments. These funds include preferred stock, common stock, bonds and REITs (Real Estate Investment Trusts).

Are mutual funds safer than stocks?

Mutual funds comprise of stocks that need to be closely monitored and managed. It invests in a variety of stocks to enable diversification, minimising the risks involved in investing in individual stocks and providing a hedge against market risks.

What is a growth and income fund?

A growth and income fund is classified under the mutual fund or exchange-traded fund (ETF) category, which involves a dual strategy of capital appreciation and a periodic source of income in the form of returns or interest payments.

What is cash fund?

Cash funds invest in cash deposits at a certain rate of interest, like a bank account. These are well-suited for investors with a low risk appetite and are often considered to be a safe investment instrument. However, they may not be effective as a long-term investment option because they do not react positively when the capital market is volatile, eroding your savings over time.

What does regular income mean?

A regular income from an income fund refers to a periodic income generated either on a monthly or quarterly basis, in contrast to capital appreciation.

What is a Monthly Income Plan?

Monthly Income Plan (MIP) is classified under the mutual fund category where the investment is proportionately assigned between the debt and equity markets in the ratio of 80:20. It is predominantly a debt-oriented mutual fund that aims to deliver pay-outs periodically every month. Being a market-linked product, it does not offer guaranteed returns. The returns from such income funds are defined by their performance. It is accompanied by low risks even when the capital market is volatile.

Which investment gives highest return?

Investments offering highest returns are enlisted below:

  • Peer to Peer Lending
  • Certificate of Deposit (CD)
  • Treasury Inflation Protected Securities (TIPS)
  • Money Market Funds
  • Municipal Bonds
  • High Interest Savings
  • Annuities
  • Online Checking Account
  • Bank Bonuses
  • Credit Card Rewards
  • Cash Value Life Insurance
  • Preferred Stocks
  • Dividend Paying Stocks

What is a good growth mutual fund?

A growth fund refers to a diversified portfolio of stocks that primarily aims at capital appreciation and is accompanied by little or no dividend pay-outs. The portfolio majorly comprises of companies with an above-average growth that re-invests the returns earned into acquisition, expansion and/or R&D. A good growth fund offers a high capital appreciation and that too at a comparatively lower risk.

Can fixed income funds lose money?

The term ‘fixed income’ should not be confused with the generation of fixed returns, which fluctuate as per capital market conditions. Fixed income funds are open to the risk of diminishing value.

What are aggressive growth mutual funds?

Aggressive growth is an investment objective of mutual fund investments that aim at high capital appreciation among growth stocks. These are stocks of companies that are estimated to grow at a comparatively higher rate than the total stock market.

What is growth fund?

A growth fund can be defined as a diversified portfolio of stocks that seek to achieve capital appreciation with little or no dividend pay-outs. This portfolio usually includes stocks of companies with above-average growth. These companies re-invest the returns earned into expansion, acquisitions and/or Research & Development.

What are low risk investments in income fund?

Low-risk investments like money market funds, certificates of deposits (CDs) and government bonds, etc., expose the assets in the portfolio to low risks, thereby, generating comparatively lower income. These are best suited for investors with a low-risk appetite.