A Investor's Guide to Income Funds

income fund

An income fund is a type of mutual fund or exchange-traded fund (ETF) that primarily focuses on generating steady income for investors, usually through dividends, interest payments or bond yields. These funds are often comprised of bonds, dividend-paying stocks or other assets that offer reliable income streams. Investors who prioritize receiving regular cash flow, such as retirees, frequently consider income funds for their portfolios. While income funds may not offer the same growth potential as equity-focused investments, they can help balance risk and provide stability, especially in uncertain markets.

A financial advisor can help you build an investment portfolio based on your financial situation and needs.

What Is an Income Fund?

An income fund is designed to invest in assets that produce consistent income, and its portfolio typically includes bonds, preferred shares and dividend-paying stocks. Unlike growth funds, which seek to maximize capital appreciation, income funds are structured to generate regular payouts to investors. This focus makes them particularly attractive for those who value stability and predictable cash flow.

These funds come in various forms, including government bond funds, corporate bond funds and even funds that mix equities with bonds to offer a diversified approach to income generation. Each type carries different levels of risk and return, making it essential for investors to consider their risk tolerance when choosing an income fund.

Additionally, income funds may also be classified based on whether they invest in domestic or international assets, providing an opportunity to diversify geographically. Fund managers actively select income-generating investments while managing risks like interest rate changes and market fluctuations. The emphasis on income over capital gains means that these funds are often less volatile compared to growth-focused funds, making them suitable for those looking to preserve capital while earning regular returns.

How Do Income Funds Work?

income fund

Income-generating funds work the same as any other mutual fund or ETF. However, they focus on investing in assets that generate steady income. That means the share price of an income fund can fluctuate from one day to the next, the same as a traditional mutual fund or exchange-traded fund.

What distinguishes one type of income fund from another is what it invests in. So for example, you may be able to invest for income using bond funds, equity income funds, money market funds or hybrid funds.

Within each income fund category, there can be further divisions. Take bond funds, for instance. You might have a fund that derives income from:

Treasuries
Municipal bonds
Corporate bonds
Junk bonds
International bonds

A single bond fund could feature all five types of bonds or focus on just one. That’s one way an income fund can help you with diversification.

Likewise, equity income funds can also offer variety. An equity income fund is stock-focused and includes stocks that pay out dividend income to investors. A hybrid fund might combine multiple income investment types, such as a mix of stocks and bonds.

Income Fund Options

Money market income funds typically cater to more conservative income investments. For instance, you might invest in a money market fund that holds certificates of deposit or Treasury bills. The income these funds generate may not be as much as an equity income fund but they tend to carry less risk.

Aside from these options, you can also find income funds that focus on real estate. More specifically, real estate investment trusts or REITs. A REIT is a legal entity that owns real estate investments, such as hotels, retail space, commercial office buildings and multifamily homes. By law, REITs are required to pay out 90% of their dividends to investors as income. Investing in a REIT income fund is a way to reap the rewards of real estate ownership without the hassle of actually having to own property.

Other income fund options include ones that hold preferred stock or Master Limited Partnerships. Preferred stock shares pay out a fixed dividend to investors and take priority over common stock shares. A Master Limited Partnership or MLP is a partnership that can be publicly traded like a stock. An MLP can offer both income and tax advantages to investors.

Pros and Cons of Income Funds

Income funds can offer several advantages but they may not be a good fit for every investor. Here’s a rundown of the pros and cons at a glance.

Pros of Investing in Income Funds

Simplified diversification: Investing in income funds can offer you broad or narrow exposure to specific asset classes. Since you’re buying multiple investments in a single fund, that could make diversifying your portfolio easier.
Stable income payouts: A good income fund generates income for investors on a regular basis. That can make financial planning for someone who’s relying on that income simpler. For example, it may be easier to map out your monthly budget in retirement when you know which investments you can count on for income.
May be cost-efficient: Income mutual funds and ETFs have expense ratios, which determine your cost of owning the fund annually. Choosing income funds with low expense ratios means you get to hold on to more of your investment earnings.

Cons of Investing in Income Funds

They aren’t risk-free: It’s a misconception to assume that income funds may be less risky than other types of mutual funds. If you’re investing in an equity income fund, for example, you’re automatically carrying a higher degree of risk than you might with a bond or money market fund.
Income and performance are two different things: It’s also important to remember that the income a fund produces isn’t necessarily equivalent to its performance. A fund’s dividend yield, for example, may force you to overlook the bigger performance picture.

How to Invest in Income Funds

If you’re thinking that income funds might fit your investment strategy, it’s important to research them the way you would any other fund.

Specifically, consider:

What the fund invests in
The fund’s expense ratio
How income pays out and how often
Historical performance

With regard to funds that pay dividends, consider the dividend yield but also look at the fund’s underlying assets. A high dividend yield is great but not if it isn’t sustainable for the long-term.

When putting together a portfolio of income funds, remember to keep diversification in sight. If you’re investing in two equity income funds, for example, you’d want to make sure that each fund isn’t investing in the exact same companies. The same goes if you’re investing in two or more bond funds or real estate funds.

You can invest in income funds through a taxable account at an online brokerage and you may also have access to them through your 401(k) or IRA. Remember to evaluate the fees and tax efficiency of any income fund so you understand how much you’ll pay to own it.

Bottom Line

income fund

Income funds can serve a distinct purpose inside a portfolio. As a result, there are several good reasons to include them as part of your retirement strategy. Take time to research different income funds. That can help you decide which of those funds may best meet your investment goals.

Investment Tips

Consider talking to a financial advisor about how income funds may fit in your investment portfolio. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
If you want to balance growth and income, consider investing in growth and income funds. These mutual funds include investments designed to offer investors the best of both worlds. They can provide an investor with both capital appreciation and income.