Income Funds: Where Do They Invest Your Money?

Income funds are a type of mutual fund or exchange-traded fund (ETF) that focuses on generating regular income for investors. They invest in a variety of securities, including high dividend-generating stocks, government securities, corporate bonds, money market instruments, and debentures. These funds offer diversification and relatively high yields, making them attractive to investors seeking stable income with lower risk. While income funds may underperform during bull markets, they tend to be more resilient during bearish markets. Additionally, income funds can be a good option for retirees or those with a low-risk tolerance who need regular income.

Dividend-paying stocks

When investing in dividend-paying stocks, it is important to evaluate the safety of the dividend by considering factors such as dividend yield and payout ratio. A dividend yield that is significantly higher than that of similar companies may be a red flag, indicating that the payout is unsustainable or that the company is going into debt to pay dividends. A payout ratio above 80% generally indicates that a large percentage of the company's income is being used for dividend payments.

For investors seeking passive income, dividend-paying stocks can be a good choice. They offer the potential for regular income and may add stability to an investment portfolio. Additionally, reinvesting dividends can enhance overall returns over time.

Government securities

In the US, government securities are sold through auctions to institutional investors. Retail investors can purchase them directly from the Treasury Department's website, banks, or brokers.

• Treasury Bills (T-Bills): Short-term securities with maturities ranging from 4 to 52 weeks. They are sold at a discount or face value and pay the face value upon maturity.
• Treasury Notes (T-Notes): Intermediate-term bonds with maturities of 2, 3, 5, or 10 years. They pay interest every six months and typically have a $1,000 face value, except for 2 and 3-year notes, which have a $5,000 face value.
• Treasury Bonds (T-Bonds): Long-term bonds with maturities between 10 and 30 years. They pay interest semi-annually and have a face value of $1,000.
• Floating Rate Notes (FRNs): The interest payments on FRNs adjust based on the discount rates for 13-week Treasury bills. They are issued for a term of two years and pay interest quarterly.
• Treasury Inflation-Protected Securities (TIPS): TIPS are indexed to inflation to protect investors from its adverse effects. The principal increases with inflation and decreases with deflation, following the Consumer Price Index (CPI). They have maturities of 5, 10, or 30 years and pay interest semi-annually.

Income funds, which aim to provide regular income, often invest in government securities. These funds are considered lower risk than those prioritising capital gains. They are suitable for investors seeking stable income with reduced default risk, such as retirees.

Corporate bonds

There are different types of corporate bonds, which vary based on maturity and credit quality. Maturity refers to the date when the company has to pay back the principal to investors, and it can be short-term (less than three years), medium-term (four to ten years), or long-term (more than ten years). Longer-term bonds usually offer higher interest rates but may also carry more risk.

Credit quality, on the other hand, refers to the likelihood of the company defaulting on its bonds. Credit rating agencies assign ratings to bonds based on the risk of default, with investment-grade bonds being more likely to be paid on time than non-investment-grade or "junk" bonds.

Money market instruments

Money market mutual funds are a type of mutual fund that invests in money market instruments. These funds are designed to be very safe investments, aiming to maintain a low share price at all times, but they tend to offer relatively low yields. While these funds don't carry the Federal Deposit Insurance Corporation (FDIC) insurance that bank products do, they have traditionally provided a high degree of safety.

• Treasury bills
• Certificates of deposit
• Commercial paper
• Repurchase agreements (repos)
• Interbank loans
• Banker's acceptances
• Federal funds
• Bills of exchange
• Short-term mortgage-backed securities and asset-backed securities

Real estate investment trusts (REITs)

REITs are an attractive investment option as they offer high dividend yields, provide a liquid method of investing in real estate, and have historically delivered competitive total returns. They are also an excellent portfolio diversifier due to their low correlation with other assets, helping to reduce overall portfolio risk and increase returns.

There are two main types of REITs: Equity REITs and Mortgage REITs. Equity REITs own or operate income-producing real estate, generating income from rents received from tenants. Mortgage REITs, on the other hand, do not own real estate directly but instead finance real estate and earn income from the interest on these investments.

REITs have specific requirements they must meet to qualify, including investing at least 75% of their total assets in real estate and deriving at least 75% of their gross income from rents, mortgages, or sales of real estate. They must also pay out at least 90% of their taxable income to shareholders as dividends.

REITs are typically structured as corporations and are not taxed at the entity level, allowing investors to avoid double taxation on dividends. They are traded on major stock exchanges, and investors can purchase shares in a REIT just like any other public stock.

When considering investing in REITs, it is important to understand the benefits and risks associated with them. While they offer attractive returns and diversification, they are subject to real estate market risks, interest rate risks, occupancy rate risks, and geographic risks, among others.

Frequently asked questions