Income fund definition
Income fund is a basket of various financial assets whose main objective is to generate regular income for the investors. It is one of the types of mutual funds, which means that you combine your resources with those of other investors and have a manager purchase the securities on your behalf. Based on the variations in market conditions, the income may not be constant. In the US, examples of an income fund include Vanguard Wellington Fund and the American Funds Capital Income Builder.
How do income funds work?
As aforementioned, an income fund is one of the categories of mutual funds. This means that instead of investing in a financial asset by yourself, you are simply required to select a fund that suits your needs. Your money, together with that of other investors in the fund is invested in a portfolio of assets such as treasury bonds and stocks. A portfolio manager is responsible for managing the investment.
Since the goal of the fund is to generate income for the investors, the portfolio will include securities that will assure you of fixed income rather than growth. However, it is important to note that the yielded amount will fluctuate from time to time depending on interest rates and other influential factors. However, you get to enjoy income payouts on a regular basis.
Factors that impact income funds
Like any other investment option, there are some crucial factors that one should consider before deciding on whether to get into an income fund. We discuss these aspects below.
Risk
An income fund is subject to two major risks; credit risk and interest rate risk. To begin with, the bond issuer may default on the payment agreed upon and subsequently affect the returns of the income fund. This is what is termed as credit risk. As for the interest rate risk, the volatility of interest rates may also impact the value of the fund.
Capital gain taxes
It is important to note that the capital gains you obtain from investing in an income fund are taxable. The applicable taxes depend on the holding period, which is the timeframe that you remain invested in the fund. The number of years that define a short or long-term capital gain may differ from one country to another.
In the US, a short-term capital gain is applicable when the holding period is not more than a year. In such a case, the taxation will be similar to your typical income. On the other hand, the taxation on long-term capital gains tends to be lower than your ordinary income. Besides, it depends on one’s yearly taxable income. IRS Form 8949 and Schedule D (Form 1040) will help you calculate your capital gain taxes.
Investment horizon
An income fund is a better alternative for those looking for a long-term option. It is one of the ways to ensure that you gain the most from the investment.
Expenses
The portfolio manager will charge you a fixed amount to manage your investment. The amount is referred to as the expense ratio. Before deciding on a particular entity, it is crucial to identify their charges. The ideal expense ratio is between 0.5% and 0.75%. A fee above 1.5% is rather high.
