Income Funds: Meaning, Features And Top Benefits
There are different varieties of mutual funds available in the market today that are meant for various types of investors. Choosing the right type of investment can help you plan your wealth in a better way. With the power of income funds, you can have a surplus added to your finances. The following sections offer a complete rundown on income funds with their features, benefits and more.
What are Income Funds?
Income funds are mutual fund schemes that provide regular income by investing in government securities, corporate bonds, certificates of deposits, debentures and other money market instruments.
These are debt funds which, according to SEBI, come with a Macaulay duration of 4 years or more. Fixed Income mutual funds are of two categories:
- Medium to Long Duration Fund (with a Macaulay duration ranging between 4 and 7 years)
- Long Duration Fund (with a Macaulay duration of over 7 years)
Top Features of Income Funds
If you are interested in investing in income funds, you should be aware of some of the key features of this scheme:
- Risk
Since income funds are a type of debt fund, they come with both interest rate risks and credit risks. Credit risk is the risk of default on debt which may arise when an issuer of the financial instrument does not repay the interest or principal. Interest rate risk occurs due to changes in the interest rates, which impacts the value of a fund’s underlying securities.
- Returns
In a falling interest rate regime, income funds can provide a return that can range between 7% and 9%. Income funds are made to benefit from interest rate volatility which helps them to fulfil the investment objectives.
- Expenses ratio
Expense ratio is the fee that a fund house levies on investors for covering the operating expenses of a mutual fund scheme. The market regulator SEBI has capped the expense ratio of an income mutual fund at 2.25%.
Benefits of Investing in Income Funds
Here are some of the major advantages of investing in income mutual funds:
- Income funds are actively managed funds. The fund managers take advantage of alterations in interest rates to deliver higher returns.
- These funds provide higher liquidity. You can easily withdraw the money any time you wish.
- Unlike fixed deposits that come with a lock-in period, these schemes provide higher liquidity and can offer higher returns as well.
How do Income Funds Work?
Income funds are managed by fund managers who ensure to provide healthy returns irrespective of the current interest rate regime. So, these funds can generate returns when the interest rates are rising or dropping.
Fund managers use the two following strategies while managing income funds:
- Earning gains: This happens when fund managers sell debt instruments as their prices jump.
- Generating interest income: Interest income is generated as the funds hold debt instruments till maturity.
Income funds invest in different debt instruments that have reduced interest rate risk. Considering past performances of these funds, they often tend to provide higher returns as compared to bank deposits. They also offer higher flexibility.
Also Read: International Mutual Funds
Process to Invest in Income Funds
You can invest in fixed income funds by visiting the branch office of the fund house. You will be required to submit self-attested copies of personal documents for identification and processing.
You can also select an online investment platform for a paperless process. Here are the steps you can follow to invest in income mutual funds online:
Step 1: Open the app or website of the investment platform and create your account.
Step 2: Submit the necessary details and documents to comply with the KYC guidelines.
Step 3: Explore the ‘Mutual Funds’ section and choose a preferable income mutual fund. Make sure that the selected mutual fund is aligned with your financial goals.
Step 4: Confirm your investment by clicking on the ‘Invest’ tab and selecting your mode of payment. You can either go for a lump-sum investment or a systematic investment plan.
Step 5: Approve the account transaction to start your investment journey.
How is Tax Calculated on Income Funds?
Income mutual funds are debt funds, so they enjoy lower tax rates than equity-based funds.
- Investors get short-term capital gains on redemption of debt fund units before the 3-year holding period. These gains are taxed as per the income tax slab rate.
- Long-term capital gains on the sale of fund units after a period of 3 years attract a tax rate of 20% and indexation benefits.
Risks Linked with Fixed Income Funds
The types of risks associated with fixed income mutual funds are:
- Liquidity risk: Fixed income mutual funds also invest in low liquidity assets such as municipal bonds. These bonds can present a problem for investors who might not be able to buy or sell bonds at the desired prices. Liquidity risk also increases during bearish markets.
- Credit risk: Debt funds carry credit or repayment risk, which means that the bond issuer might be unable to make the pre-defined principal or interest payments on time. Sometimes, businesses or the government might not be able to fulfil their debt obligations due to huge financial losses or a calamity.
- Interest rate risk: Bond prices in the money market heavily depend on the economic condition of the country, which can be significantly affected by changes in the interest rates. Interest rate fluctuations can change the market price of the bonds.
- Inflation risk: The purchasing power of the investor is inversely proportional to the rise in inflation. During inflation, the value of the returns earned by investors will significantly reduce. This can be detrimental for investors who plan to live off their profit from fixed income funds.
What are the Differences Between Income Funds and Growth Funds?
While income funds offer a steady stream of income for the investor, growth funds aim to increase the value of his/her investments over time. The key differences between the two types of mutual funds are:
| Income Funds | Growth Funds | |
| Goal | Generate a steady income for the investors | Achieve high levels of growth on investments |
| Returns | Offers fixed and regular payouts to shareholders | Appreciated capital is reinvested into the fund |
| Risk | Low | High |
| Portfolio | Focused on companies that pay dividends to their shareholders. | Focused on companies who are aiming for expansion and growth |
How to Select the Right Income Fund in India?
Fixed-income mutual funds offer a steady stream of income with fewer risks than equity-based funds. Investors who wish to take advantage of money-market instruments can go for fixed incomes funds.
Here are a few points that one should keep in mind before investing:
- Credit quality of the mutual fund: The credit quality of the securities in a portfolio reflects the repayment capabilities of the debt fund. Funds that invest in high-quality securities will potentially deliver guaranteed returns.
- Average maturity of the portfolio: The average maturity of a debt fund denotes the average of all the maturity periods of the bonds held in the fund. The longer the average maturity, the more fluctuations the bond price faces due to changes in interest rates.
- Investment goals: Investors should invest in debt funds as per their financial goals. Different fixed income funds come with varied maturity periods: long-term (more than 10 years), mid-term (3-10 years) and short-term (1-3 years). The average maturity period of the income fund should align with the return goals of the investor.
- Performance: A fund’s total yield over time is an indication of the fund’s potential to generate suitable returns. Investors should assess the credit risk, return rates, issuer history, qualifications of the fund management team, etc., to understand the income-generating potential of the debt fund.
Factors to Consider Before Investing in a Mutual Fund
To make the most out of your mutual fund investment, you need to consider the following vital factors before you make an investment:
- Investment objective
You need to fix the financial goals that you intend to fulfil through your investments in mutual funds. This can be building a retirement, funding your child’s education or marriage. You should chalk out an investment objective and invest in schemes that align with these objectives.
- Mode of investment
If you are planning to invest in a mutual fund, you can either choose the lump sum mode or the SIP mode of investment. For the first mode, you need to make a one-time investment of a bulk amount in a mutual fund. However, with a SIP or systematic investment plan, you have to make a payment of a fixed amount at a specific interval. You can invest monthly, semi-annually, quarterly, or yearly.
- Expense ratio
A portion of your investment will go towards paying the expense ratio, which is a fee that a fund house imposes on investors to cover the scheme’s operating expenses. Make sure to compare the expense ratio of different income funds before making an investment.
- Past returns
By analysing the past returns of a mutual fund, you can assess how well a scheme has been running. This will help you to determine whether you should put your money into a particular scheme. But you need to remember that past returns of a mutual fund do not predict how its future performance would be.
- Risk appetite
Every investor will have different levels of risk-bearing capacity. Some might have a higher risk tolerance, while others might be averse to risk. Since there are numerous schemes that come with varying levels of investment risk, you need to invest in funds that are suitable for your risk profile.
- Track record of the fund manager
Most mutual funds are actively managed by fund managers. They are responsible for making sure that a mutual fund fulfils its predetermined objectives. Hence, it is vital to check the track record and experience of a fund manager before investing in a mutual fund scheme.
Also Read: List Of Best Value Mutual Funds
Final Word
Income funds invest in debt instruments to provide regular income for investors. Apart from investing in income funds, you can also opt for debt funds on Navi. You can invest in Navi Ultra Short Term Fund or the Navi Liquid Fund, and more. Visit Navi Mutual Fund and start investing with just Rs. 500.
FAQs on Income Funds
Ans: The short-term capital gains that you earn from investing in income funds are liable to taxation as per your tax slab rate. However, the government will tax your long-term capital gains from income funds at a 20% rate after indexation benefits.
Ans: Income mutual funds are highly suitable for those investors who have a low or moderate risk-bearing capacity and an objective to earn regular income. So, if you are looking to explore low-risk schemes that provide stable returns, you can consider investing in these funds.
Ans: Income funds help in generating regular and steady earnings for investors; they are also comparatively less risky. Growth funds provide capital appreciation by reinvesting the returns and thus have the potential to deliver high growth.
Ans: Yes, similar to other types of mutual funds, you can invest in income funds through a systematic investment plan. Income funds are a type of debt funds that offer superior returns with lesser volatility and risk as compared to equity funds.
Ans: Macaulay duration is the time that you, as an investor, would need to get back the money you invested in a bond in the form of both periodic interest and principal repayment. It is a vital parameter that fund managers use while building a portfolio that is suitable for prevailing market conditions.
Ans: Credit quality is one of the most important factors to judge the returns on income mutual funds. The credit quality or “bond rating“ defines the creditworthiness or bond’s ability to pay back the fund to the investors. Fixed income bonds with high credit ratings are considered low-risk investments. You should check the mutual fund’s portfolio to understand credit risk.
Ans: Investors with the objective of earning a regular income from the debt market can invest in fixed income mutual funds for 1 to 3 years. The ideal entry time is when the interest rates are low, which will ensure high returns during price appreciation.
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Disclaimer: Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.
This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.
