WHAT ARE INCOME FUNDS?
Income funds are mutual funds that aim to generate an income stream for the investors by investing in securities and instruments that offer interest and dividends. These are basically debt funds that invest in either highly rated government bonds, corporate bonds, and Money Market Instruments for a long tenure. Here, the significance is given to protecting capital rather than appreciation, so fund managers tend to be a little more cautious while investing. The SEBI classifies these funds as those funds whose Macaulay duration is equal to or more than 4 years. Thus, there are broadly 2 types of funds that come under the Income mutual funds. The first one is ‘Long Duration Funds’ having more than 7 years tenure and ‘Medium to Long Duration Funds’ having tenure ranging from 4 to 7 years.
HOW DO INCOME FUNDS WORK?
Income funds can be conservative to investments having high risk, depending on the holdings. Some funds only invest in instruments from creditworthy and established companies that make consistent interest payments or dividends, making them relatively conservative investments. Other funds may invest in investments having slightly moderate to high risk like low-rated bonds and REITs and aim for higher yields than other more conservative funds. One of the greatest edges of income funds is that it offers diversification. Income funds act as a hedge against market risk as they invest in debt securities like bonds and other fixed income instruments.
It is significant to know that the goal of maximizing income does not always result in regular payments to investors. Some income funds do not make regular payments to investors, instead, they make special payments when feasible. Investors should read the fund’s documents and prospectus and do the needful research before investing.
FEATURES OF INCOME FUNDS
Income funds invest in a number of fixed income investment options so the risk is spread out. Also, many of these options are not open to retail investors. For instance, you can not purchase government bonds or treasury bills on your own; only institutional investors are permitted to buy them on a wholesale basis.
2. Expense Ratio:
This is the percentage of the total assets of the fund which the AMC levies as a fee for offering fund management services. SEBI has created an upper limit at 2.25% on income funds. A fund with a high expense ratio has a direct impact on the returns as the returns on these funds are not very high because they are debt-based.
3. Low Risk:
One of the significant features of these funds is the low credit and default risk level. Since fund managers aim more on capital protection, investments are made in either corporate debt, government bonds, or money market instruments with high credit ratings. But there exists interest rate risks due to holdings with long durations which means in response to interest rate changes in the economy, the value of these funds is expected to fluctuate.
TAXATION FOR INCOME FUNDS
Income funds are subject to capital gains tax which is levied according to the holding period which is the period for which you hold the units of the fund - or the period between buying and redeeming the units.
If the holding period is upto 3 years, STCG is levied and this is added to your total income and taxed as per the tax slab.
If the holding period is more than 3 years, then LTCG is levied at 20% after indexation benefits.
THINGS TO CONSIDER BEFORE INVESTING
- Goals and Vision:
Your goals and vision must be steady income and low risk. Income funds are ideal for these types of investors. It’s also ideal for those who want to save up money to meet long-term goals like buying a house or accumulating enough corpus for a certain project.
2. Fund Managers:
A good fund manager is the management behind the fund. They are the mind, knowledge, and skills behind the funds. Information about them is available in the public domain so make sure you go through the same.
Before opting for the income fund, investors should have a look over the portfolio and see what instruments it includes. You can easily rely on high-quality and rating bonds but if there are any low rating bonds you must do the needful research and consult your financial advisor before opting for the same.
4. Investment Horizon:
Income funds are ideal for investors who have a longer time period for investment, say, 4 years or more. If you are someone who wants to park funds for a short period, you may opt for liquid funds, low-duration funds, corporate bond funds, etc. as per your investment requirements. Also, you get an indexation benefit if you hold the fund for more than 3 years.
5. Modified Duration:
Modified duration can be simply termed as the price sensitivity of an instrument or bond with respect to changes in interest rates. For instance, if the modified duration of a fund’s portfolio is 7 years and the interest rate goes down by 1%, then the NAV of the fund is expected to rise by 7%.
WHO SHOULD INVEST IN INCOME FUNDS?
Income funds are ideal for investors looking for long-term alternatives, want to protect their capital first, and have a conservative mindset which means not willing to take many risks. These can also prove to be good for investors who are particularly looking forward to investing in high-quality papers and instruments.One important thing to consider here is that these funds have long durations and therefore they will carry high-interest rate risks.
Frequently Asked Questions (FAQs)
1. What are Income Funds?
Income funds are those mutual funds that aim to generate an income for the investors by investing in securities and instruments that offer interest or coupon payments.
2. On what principle do income funds work?
The working principle of these funds is to invest in alternatives offering consistent income in the form of interest or coupon payments.
3. What are some of the key features of Income Funds?
Diversification along with low risk and decent returns are some of the key features of income funds.
4. What aspects are to be looked upon before investing in Income Funds?
Some key aspects to go through before investing in these funds are profiles of fund managers, the goal of the individual, information about the portfolio, modified duration, and the tenure for which the investor is willing to invest.
5. What are the taxation norms for Income Funds?
Income funds are subject to capital gains tax. If the holding period is upto 3 years, STCG is levied and this is added to your total income and taxed as per the tax slab. And if the holding period is more than 3 years, then LTCG is levied at 20% with indexation benefits.