Mutual funds are among the most versatile investment options in India. Depending on the type of funds you choose, you can meet different investment goals across various time horizons. One such goal may be to earn regular income from your investments. Income funds can help you meet this objective easily.
In this article, we delve into what an income fund is, explore how it works and understand the features of income funds.
What is an income fund?
As the name indicates, income funds are a category of mutual funds that offer the benefit of periodic or regular income to investors. While the primary objective of these funds is income generation, capital appreciation may also be an added secondary advantage. To meet this objective, income mutual funds invest in a variety of assets that offer periodic income in different forms.
For instance, government securities, bonds and certain other debt instruments offer period income in the form of interest payouts. Certain stocks, on the other hand, pay out dividends periodically. By investing in a basket of such assets, income funds generate regular income that is paid out to investors who have purchased units in these schemes.
How do income mutual funds work?
Income mutual funds work quite like many other types of mutual funds. Since they do not track any index, they are actively managed. This means that a fund manager is responsible for selecting the stocks, bonds and/or other securities that will form the fund’s asset portfolio. The selection process takes into account various aspects like the income generation potential, risk levels and other aspects of the instruments.
Typically, when choosing assets for the portfolio in income funds, asset managers focus on two strategic objectives, as outlined below:
- Income generation: This objective is achieved by investing in income-generating securities and assets.
- Capital appreciation: This objective is achieved if the securities of the fund are redeemed at a higher NAV than their purchase cost.
If you invest in an income fund, you will continue to earn income as per the fund’s payout terms. Additionally, when you redeem your holdings, if the NAV at the time of sale is higher than the NAV at the time of purchase, you will also earn the benefit of capital gains from this redemption.
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Features of an income fund
To make an informed decision about investing in an income fund, it is essential to understand the key features of this investment category. So, here is an overview of the defining characteristics of income mutual funds.
- Interest rate sensitivity: Income funds, particularly those that invest in fixed-income securities and debt instruments, can be highly sensitive to changes in interest rates. While the income generated may not be highly impacted, the value of the investments (and consequently the NAV of the fund units) fluctuates as the interest rates change.
Credit risk: This type of risk reflects the ability of the issuer to repay the principal and the interest (or any other payments) due on a security. Since an income fund invests in a wide range of securities, each of which has its own credit risk, the fund itself is subject to the combined effect of such risks.
Dual objectives: One of the most defining features of income funds is that they focus on the twin advantages of income generation and capital appreciation. Although the priority is to offer income benefits to the investor, these funds may also offer the advantage of capital gains depending on how the asset values change over the investment period.
Expense ratio: Like most mutual funds, income funds also levy a fee to cover various expenses like administrative costs, fund managers’ fees, operational expenses and more. The expense ratio impacts the overall returns you earn from your investment in income mutual funds. So, ensure that you track these details before investing.
Liquidity: Since income funds do not have any lock-in period, they can easily be redeemed. This offers greater liquidity than other investment avenues that have fixed investment tenures. So, if you want the freedom to liquidate your investments according to your investment horizon, these funds may be ideal options to consider.
Is an income fund suitable for you?
An income fund may be suitable for you if your investment goals align with the fund’s objectives and if its risk levels match your risk tolerance. More specifically, an income fund may be a valuable addition to your portfolio if:
- You are looking for regular income from your investments
- You want to preserve (and possibly grow) your capital and also earn income in the process
- You want to diversify your portfolio with fixed-income securities
- You are looking for an additional or alternative source of steady income
- You want to benefit from the expertise of a fund manager
Conclusion
Income mutual funds make a fine addition to your portfolio if you are looking for an additional or alternative source of earnings. However, before you choose income funds for your portfolio, ensure that you do your due diligence, compare the funds in the market and select the ones that best align with your investment goals and risk tolerance levels. The Bajaj Finserv Mutual Fund Platform has more than a thousand funds to choose from. Go ahead and explore the various funds and find the ones that meet your needs.
