Income Funds - Types, Features & Examples

Last Updated on Apr 25, 2025 by vanessa sequeira

The mutual fund industry has been actively developing a range of investment strategies and products to cater to the diverse needs and risk tolerances of investors. One such offering of the industry is income funds. Income funds focus on generating consistent and regular returns for investors through dividends or interest by investing in fixed income instruments, money market instruments, and certificates of deposit. Let’s deep dive to understand what mutual income funds are, who can invest and how to choose the best income mutual funds.

Table of Contents

What Are Income Funds?

An income fund is a type of mutual fund scheme that focuses on providing a regular source of returns for the investors by investing a significant portion of the pooled investor capital in fixed income securities. Standard investment vehicles within income funds include government securities, corporate bonds, debentures, and money market instruments, among others. Investments in income generating funds should be held for longer durations to benefit from them, and they are generally not suitable for short-term investors.

How do Income Funds Work?

Income funds emphasise current income and have an overall low-risk factor. The focus is on current income and capital preservation, rather than capital gains or rapid appreciation.

The idea of an income fund is that it can generate returns irrespective of the interest rate mechanism. Hence, income fund managers will work towards generating income from interest by holding debt instruments until maturity and earning gains by selling them in the market when their prices increase. These funds are highly liquid and offer greater flexibility to investors for redemption and withdrawal than fixed income instruments.

Features of Income Funds

Top income funds are primarily focused on generating regular income through interest and dividends. Here are some key features:

Focus on Debt Instruments: Debt income funds predominantly invest in debt securities such as bonds, government securities, and corporate bonds. These instruments provide fixed returns over a specified period.
Regular Income Distribution: An income fund portfolio is ideal for investors looking for regular income, as they typically pay interest or dividends on a monthly, quarterly, or annual basis.
Low to Moderate Risk: Compared to equity funds, income funds are relatively lower in risk due to their focus on fixed-income instruments. However, they are not risk-free, as the returns depend on the performance of the underlying debt assets.
Diversification: Many top-performing income funds invest in a diversified portfolio of debt instruments, which helps in spreading risk and enhancing the stability of returns.
Liquidity: Income funds are usually more liquid than other types of funds, as they invest in debt securities that can be bought or sold easily in the market.

Types Of Income Funds

Money market funds

Money market funds are income funds that invest the pool of investors’ money in certificates of deposit, short-term treasury bills, or commercial papers – essentially, money market instruments that are short-term, liquid investments. Generally, income funds for long-term is low-risk and low-cost. However, the return yield is also low. The concept is to invest in short-term assets that can be converted into returns at the lowest cost.

Bond funds

Corporations and the Government can issue bonds that pay annual interest to the investor. Although the interest yield of a government bond is low, it tends to be much safer, with zero to marginal risk, compared to corporate bonds, which offer high interest but involve a substantial amount of risk.

Equity income funds

Equity income funds are a slightly different type of fund that invests in high-dividend-paying stocks. It aims to generate steady monthly income for investors from the dividends announced by companies. Note here that these are equity-oriented funds and not debt-oriented funds. The risk is higher due to the direct exposure to the stock markets.

Factors to Consider Before Investing In Income Funds?

Risk factor

A debt fund comes with fewer risks, regardless of its type. However, they are not risk-free. Short-term income funds carry both credit risk and interest risk. Bond prices could decline significantly if interest rates rise. Similarly, if the issuer of the bond fails to make payments, investors risk losing their capital.

Investment horizon

Investors who have an investment horizon of at least 3-4 yrs may find fixed income funds suitable for them. Fixed income products generally offer low yields, and therefore, investing for a longer term can help accumulate wealth. Income funds might not be the right choice for short-term investors.

Expense ratio

The expense ratio is the total fees that a fund house charges for managing the fund and its assets. Ideally, investors must look for income funds with high returns and a low expense ratio to ensure high returns.

Benefits Of Income Funds

High liquidity: Income funds come with no lock-in periods, and hence, withdrawing the funds is relatively easy compared to fixed deposits. However, some funds might have exit load fees for early withdrawal.
Stable income: Investors prefer income funds for the stability of returns they offer. They generate regular income along with being low-risk investment avenues. However, all investments are subject to market risks, and returns are not guaranteed.
Higher returns than FDs: High-return debt funds are a great way of getting a higher return on your investment than direct investment in fixed income products, even in times when interest rates fall.
Diversification of portfolio: When you invest in fixed income products, you are subscribing to only one investment. However, the best income funds spread the risk across a variety of fixed income products and fetch cumulative returns from the space to add to your portfolio.

Risks of Investing in Income Funds

While income funds are often considered low-risk, they still carry certain risks. Here are some key risks to be aware of:

Interest Rate Risk: The most significant risk in income funds is interest rate risk. When interest rates rise, the price of existing bonds falls, which can impact the overall return of income funds.
Credit Risk: This risk refers to the possibility that the issuer of a debt instrument may default on its payments. While government securities are generally considered safe, corporate bonds carry more credit risk.
Inflation Risk: Inflation can erode the real value of the returns generated by even the best income funds. If inflation outpaces the returns generated by the fund, the purchasing power of the income received may decrease.
Liquidity Risk: Although mutual income funds are typically liquid, there may be instances where the underlying securities are difficult to sell, particularly in periods of market volatility.
Manager Risk: The performance of income generating funds is also dependent on the fund manager’s decisions. Poor management can lead to suboptimal returns.

How To Invest In Income Funds?

Income funds are essentially a type of mutual fund or an ETF. Just as with investing in mutual funds, it is essential to thoroughly research income funds. Understand its investment strategy, who manages it, its track record, and how high or low the expense ratio is.

Investment in income funds can be done digitally by opening an account on a trading platform. This can be with a broker, a mutual fund distributor or with the mutual fund house directly. The investor will then have the option to choose between the lump-sum model and the SIP model of investment in their preferred income fund. The same KYC documentation that applies when investing in mutual funds and ETFs apply to income fund investing too.

Who Should Invest In Income Funds?

Since income funds compensate the investor monthly or quarterly, they are best suited for individuals seeking a steady and regular income. Investors with a low to moderate risk profile can also consider income funds to get returns. New investors considering entering the mutual fund space may consider investing in income funds. For investors considering income funds for retirement, it is essential to note that they typically offer low yields but can generate significant returns over the long term.

The characteristics of income funds are most relevant to retired individuals or those nearing retirement who seek to protect their investments from volatility and risk while growing their wealth.

How to Choose Income Funds

Selecting the right income fund requires careful consideration of various factors. Here’s how you can choose the best income funds for investment:

Assess Your Risk Tolerance: While most income funds are lower in risk compared to equity funds, there are still differences in risk profiles. High-yield income funds tend to have more volatility, while low-risk income funds offer more stability.
Look for Fund Performance: Review the fund’s historical performance, particularly during periods of interest rate fluctuations. A fund that has consistently performed well, even in difficult market conditions, is a strong candidate for investment.
Check the Fund’s Asset Allocation: Different funds have different strategies for investing in debt instruments. Some may invest heavily in government securities, while others may focus more on corporate bonds. Ensure the asset allocation aligns with your risk preferences.
Fund Expenses: While income funds generally have lower expense ratios compared to equity funds, you should still compare the expense ratios of different funds. High fees can eat into your returns over time.
Fund Manager’s Track Record: A good fund manager can significantly impact the fund’s performance. Look for income funds managed by experienced professionals with a proven track record in managing debt investments.

To Wrap Up

Income funds are an alternative method of generating passive income in the market and can serve as an excellent retirement strategy. They are low-risk investments that focus on slow capital appreciation over time, and are a consistent source of income.

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Ayushi Mishra

Content Writer at Tickertape

With a wealth of experience as a content writer at Tickertape, Aayushi is passionate about simplifying complex investment modules for the platform's audience. Her writing offers a fresh perspective on the financial world, keeping readers captivated with the latest industry developments. Aayushi's ability to break down financial jargon into easily digestible content sets her apart as a writer who truly understands the needs of her readers.