What is an Income Fund and How it Works?

There are several investment schemes to cater to various categories of investors. However, such a wide variety tends to be confusing for individuals. One such popular investment option includes income funds.

Successful investing demands a well-researched and thorough approach to avoid potential pitfalls. This is why individuals willing to opt for this option must first have detailed knowledge on how they work and things to consider before allocating funds.

Income funds fall under the category of debt mutual funds. Accordingly, such schemes invest in fixed-income securities, which include bonds, debentures, money market market instruments, and more. The main objective of an income fund is to provide investors with regular income as well as stability.

Since the portfolio of these funds does not comprise equity and equity-related instruments, their performance is not impacted by price fluctuations in the stock market. Accordingly, they carry lower financial risk than equity funds. That said, there is the limited scope of capital appreciation owing to the lack of equity exposure.

A fund manager invests in fixed-income instruments that have established financial track records and high credit ratings. Such organizations have lesser default risk in the repayment of interest and capital.

An income fund’s net asset value (NAV) is impacted by the changing interest rates in the economy. In a falling interest rate regime, the NAV of an income fund is likely to increase, and vice versa. The fund manager actively manages the portfolio to provide maximum returns irrespective of whether interest rates in the market are increasing or decreasing.

Income funds earn income on their investment in fixed-income securities via the following two ways:

• Interest payments: These funds receive interest payments if they hold the debt securities until the end of their maturity period.
• Price appreciation: In case interest rates in the market fall, the price of the fixed-income securities rises. Fund managers take advantage of this scenario and offload the holdings at the increased price to make financial gains.

Income funds are ideal for risk-averse investors who are seeking stable and regular income. For example, retired individuals requiring funds for meeting their daily expenditures might prefer income funds to other fund types.

Furthermore, conservative investors willing to earn higher returns compared to their conventional havens, such as savings and fixed deposits, might also consider investing in income funds.

Even individuals with greater risk appetites who prefer investing through equity or equity-oriented schemes can look forward to allocating a part of their savings to income funds for diversification purposes.

If an individual decides to invest in income funds, he/she has to choose the type of plan first. In that regard, there are two available  options:

• Direct plan: These mutual fund schemes are offered by asset management companies directly. Individuals can choose to invest in a direct plan through the fund house’s official website. Alternatively, they can allocate their funds via certain online platforms/mobile-based applications.
• Regular plan: When investors invest in a scheme via a broker/distributor, they are opting for a regular plan. In comparison to direct plans, regular plans have a higher expense ratio as the fund houses need to pay commission to the intermediary. Accordingly, they report a lower NAV. However, investors might still consider investing via a regular plan for advisory services.

Note that a direct plan has a lower expense ratio in comparison to a regular plan as the fund house does not have to pay any distribution fee to brokers/distributors. Moreover, for this reason, the NAV is higher in the case of the former.

After deciding which plan to opt for, investors need to decide the investment mode. They can choose to invest via a systematic investment plan (SIP) and allocate a fixed sum at regular intervals (monthly, quarterly, etc.) to a scheme. Alternatively, they might invest the entire amount available with them by opting for the lump sum mode.

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