Income Funds

Definition of Income Funds

An income funds is a mutual fund or an exchange-traded fund (ETF) whose main objective is to provide stable income to its investors from their investments. The income fund emphasizes more on current income rather than capital gain income. They invest in bonds, securities, shares, and dividend stocks.

Explanation

Income funds are majorly debt funds, i.e., they majorly invest in instruments of debts such as debentures, government securities, corporate debt obligations, etc. The objective of such funds, irrespective of the asset class they invest in, is to generate current income for its investors and distribute them regularly amongst the investors. Such investments are usually for a long time, usually four or more years. It always tries to meet the objectives of investors looking for a stable return with low risk. The price of the income fund shares varies depending upon the interest rate. The price of the shares increases with the decrease in the interest rate and vice versa.

Features of Income Funds

Some of the salient features are as follows:

• In income funds, there is safety for the investors as there is a reduction of risk in it, which is a favorable factor for the investors who tend to avoid risk in investments.
• The return rate is high compared to the risk factor, and the investor enjoys stable income against their investments.
• The investment in the income fund enjoys good liquidity since the shares can be liquidated even before the maturity date; however, the investor will get less return on it.
• It is managed by professional managers who charge some investment management fees, which are included in the expense ratio. A high expense ratio results in the reduction of return on such investment.

Examples of Income Funds

• Rowe Price Equity Income fund: It is one of the largest income funds which invests at least 80% in stocks with priority on large-capitalization stocks. According to the latest studies, the T. Rowe Price Equity fund has $21.23$ billion in assets.
• Lipper Equity Income Funds Index: It is an example of an income fund whose index is unmanaged, and it is not possible to invest in such an index directly. It usually finds funds seeking high current income by investing at least 65% in dividend-paying equity securities.
• Vanguard Equity Income Fund: This fund provides investors with more than the average level of current income while providing exposure to the stock market. Such funds prioritize the companies that are growing slowly and yielding higher. Therefore, it is suitable for investors looking to invest in the long term.

Taxation on Income Funds

The tax to be paid on the income fund can be determined by the type of distribution received, the duration of the investment holding, and the type of investment. After this, an investor can calculate the taxes on the income fund. The taxation on income funds can be categorized in the following three points:

• Dividends: The dividends received are taxed as ordinary income if the income funds trade in dividends more often. For example, if you receive $10,000 in dividends as payment on investment and the investor pays 24% income tax, then the investor has to pay $2400 as a tax on income funds.
• Interest: If the investor invests in tax-free income funds, it will reduce the income tax liability since such interest will be exempt from income tax. Such funds invest in the bonds of government and municipality as these provide tax-free interest on investment and are stable and safe. If the funds are not tax-free, then the interest income will be taxed as the taxpayer’s ordinary income.
• Capital Gains: Profitgenerated by selling any capital asset over and above its purchase price is referred to as Capital Gain. The taxation will depend on the jurisdiction of the income fund. For example, in the US, short-term capital gains are taxed as ordinary income, and the tax on long-term capital gains is based on the level of income earned, i.e., for some income levels, the tax may be zero, and for some higher levels tax rate might be higher.

Who Should Invest in Income Funds?

Investors with moderate risk tolerance and seeking a fair and stable investment should invest in income funds. However, any investor with requisite funds can invest in these funds as professional managers will look after their objectives of getting regular payments with low risk. They are also favorable for newbies willing to explore mutual funds.

Advantages

Some of the advantages are given below:

• Professional Management: Some professional managers manage the investment in the income fund. Such managers are highly educated to generate a high return rate.
• Reduction in Risk: In income funds, there is more safety for investors as there is a low level of risk as the investments are invested at different asset classes, and thus, the loss of one investment gets covered up by the profit of the other.
• Stable Income: There is stability in return in the income fund as such funds distribute the returns to its investors frequently, such as monthly, quarterly, and so on.
• Liquidity: The investor enjoys the advantage of liquidity in the income fund even before maturity, but the investor will get a low rate of return if liquidation is done before the maturity date.

Disadvantages

Some of the disadvantages are given below:

• High Charges: Professional managers in the income fund charge fees for their service, increasing the expense ratio. The investor would get a lower return on investment.
• Mismanagement: There is a possibility of mismanagement by the managers in the income fund as the managers do all the work. If the managers are not working efficiently, they can do mismanagement.
• Long Term Investment: The investment in the income fund is usually for a long time, so if the investor is in urgent requirement of the fund, the investor can liquidate, but it will cost the investor in terms of a low rate of return.

Conclusion

An income fund is important as it attracts customers, avoids risk, and seeks a stable income. Investors looking for current income distributions can benefit largely from these funds, especially in a higher age group.

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