What Is an Income Fund?
Let me explain what an income fund is. It's a type of mutual fund or exchange-traded fund (ETF) that focuses on generating current income for you, the investor, through investments in bonds, preferred stock, and dividend-paying stocks.
An income fund emphasizes current income, which you might receive monthly or quarterly, rather than focusing on capital gains or appreciation. These funds typically hold a variety of government, municipal, and corporate debt obligations, preferred stock, money market instruments, and dividend-paying stocks.
Key Takeaways
- Income funds are mutual funds or ETFs that prioritize current income, often in the form of interest or dividend-paying investments.
- Income funds may invest in bonds or other fixed-income securities as well as preferred shares and dividend stocks.
- Income funds are often considered lower risk than funds that prioritize capital gains.
The Basics of Income Funds
You should know that share prices of income funds are not fixed; they tend to fall when interest rates are rising and to increase when interest rates are falling. Generally, the bonds included in the portfolios of these funds are investment-grade. The other securities are of sufficient credit quality to assure the preservation of capital.
There are two popular types of high-risk funds that also focus mainly on income: high-yield bond funds that invest primarily in corporate junk bonds and bank loan funds that invest in floating-rate loans issued by banks or other financial institutions.
Income funds come in several varieties. The primary differentiation involves the types of securities they invest in to generate income.
Money Market Funds
Money market funds generally invest in certificates of deposit (CDs), commercial paper, and short-term Treasury bills. These funds are designed to be very safe investments aiming to maintain a low share price at all times, but they also tend to offer relatively low yields. While these funds don't carry the Federal Deposit Insurance Corporation (FDIC) insurance that bank products do, money market funds have traditionally provided a high degree of safety.
Bond Funds
Bond funds typically invest in corporate and government bonds. Government bond funds carry virtually no default risk and, therefore, can act as a safe haven for you in times of uncertainty, but they normally offer lower yields than comparable corporate bond funds. Corporate bonds carry the additional risk that the issuer may not be able to make principal or interest payments. As a result, they tend to pay higher interest rates to account for the additional risk. Corporate bond funds can be split into investment-grade bond funds and below-investment-grade, or junk, bond funds.
Equity Income Funds
Many companies pay dividends on their stocks. Funds invested primarily in stocks that pay regular dividends are known as equity income funds. These types of funds are especially popular among retirement-age investors that look to live off of the predictable monthly income generated from their portfolios. Historically, dividends have provided a significant percentage of a stock's total long-term return.
Other Income Funds
Other income-producing funds include those focused on real estate investment trusts (REITs), master limited partnerships (MLPs), and preferred stocks.
Example of an Income Fund
Take the T. Rowe Price Equity Income Fund as an example. It has $17.51 billion in net assets as of Q1 2021 and seeks a high rate of growth through high dividend-paying stocks in combination with capital appreciation. The fund, which distributes payouts quarterly, paid a dividend of $0.18 per share on Dec. 14, 2020. The fund has performed relatively in line with its benchmark. An investment of $10,000 in the T. Rowe Price Equity Income Fund at inception in 1985 would be worth around $245,100 as of Feb. 28, 2021. The Lipper Equity Income Funds Average result for the same amount over the same period would be about $251,500.
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