Income funds are a specific type of debt mutual funds that invest predominantly in money market instruments like government securities, corporate bonds and more. It's an excellent investment product for investors who look for a steady income. Here, in this guide, we give you all that you need to know about income funds – features, benefits, types, how to choose the right one, and top-performing income funds in India. 

What are income funds? 

Income funds are a type of debt-oriented mutual funds. As the name implies, these fund schemes generate a steady source of income for investors. The funds offer diversification of the portfolio, by investing in government securities, corporate bonds and other money market instruments like Certificates of Deposits (CD).

Income funds allocate funds in assets that generate higher interests. The high dividends earned from these funds are distributed to investors or reinvested in the fund.

The Working of Income Funds 

The NAV of income funds is computed up to four decimal places. Income funds generate returns for investors both during rising interest rates and declining interest rates. The fund manager can adopt any one of the following two strategies:

  • Earn interest from debt instruments by holding them till maturity 

  • Sell debt instruments in the fund at a higher price 

The fund manager achieves higher returns by investing your funds in money-market and debt schemes that have higher stability and relatively lower levels of risk. Majority of times, income funds offer higher returns compared to other traditional modes of investment like bank fixed deposits. Also, income funds offer higher flexibility as there are no lock-in periods, and you can redeem your units as and when required.

Additional Reading : A Beginner's Guide to Understanding Mutual Fund NAVs

Types of Income Funds in India 

Classification of Income Funds based on Investment Horizon 

As per SEBI, income funds are categorised as, 

  • Medium to long-duration income funds – These are open-ended debt funds that invest in money-market and other debt instruments. The Macaulay Duration of these funds is from 4 to 7 years. 

  • Long duration income funds – These are open-ended debt funds whose investment period is more than seven years.  

Classification of Income Funds based on Asset Allocation 

Let’s take a look at the popular income fund categories based on the underlying assets. 

  • Bond Funds – Bond funds invest in debt instruments like mortgage-backed securities and government bonds. Bond funds generate interest annually. This interest can be used to supplement the income of the investor. Government departments and other corporations issue them.  

  • High-yield Bond Funds – As the name implies, these funds generate higher returns compared to regular bond funds. However, with higher yields, these funds are riskier compared to bond funds. High-rated investment-grade companies issue high-yield bond funds.

  • Global Bond Funds – These funds invest in a range of private and public entities across the world. It includes bonds issued by various governments, international bodies, local authorities and private corporations. 

Other categories of income funds include equity income funds and multi-asset income funds.

Benefits of Investing in Income Funds 

Income funds are a great investment choice for investors of all ages. It provides a supplementary source of income that acts as financial support during an emergency. When used rightly, it also works as an effective retirement planning strategy. Here are a few benefits of investing in income funds:

  • Generate Better Returns compared to Traditional Bank Fixed Deposits

Historically, income funds have generated higher returns when compared with 3-year fixed deposits. It’s a common practice for Indians to park their surplus income in fixed deposits. However, if you wish to generate higher returns, then you can opt for income funds over FDs. 

  • Higher Liquidity 

One of the most significant drawbacks with bank fixed deposits is that it doesn't offer liquidity. Withdrawing funds before maturity is not always possible, and even when possible, it comes with penalties.

On the other hand, income funds allow investors to withdraw their funds as per their convenience. 

  • Higher Flexibility 

Besides withdrawing your entire corpus, you can also opt for a systematic withdrawal feature. This benefit helps you to withdraw money at regular intervals, thereby providing you with a steady source of alternative income. 

  • Tax-Saving 

The income generated from income funds is considered as LTCG (Long-term Capital Gains) after a holding period of one year. This income is taxed at 10% without indexation and 20% with indexation. Thus, it offers higher tax savings for people in the higher income tax slabs.

Who should invest in income funds? 

Income funds are ideal for investors:

  • Looking to generate stable and regular income. For instance, retirees can park their surplus funds in an income fund and generate additional revenues to meet their day-to-day expenditures. 

  • Investors who do not wish to expose their funds to high risk. Income funds provide them with a relatively low-risk investment option, with higher returns.

Factors to Consider before Investing in Income Funds 

  • Low risk doesn’t mean zero risk

Just like all other mutual funds, income funds have certain inherent risks. For instance, with a gradual increase in interest rates, the value of the underlying bonds take a fall, which, in turn, leads to a decrease in fund value. Also, there is the risk that the issuer of the bond may default on payments (it happens very rarely), which can impact fund value.

Fund managers in an attempt to increase returns may invest in low-rated bonds, thereby increasing the overall risk of the portfolio. 

  • Income funds have the potential to offer higher returns compared to bank FDs 

Income funds are an excellent investment opportunity to increase your profits. Especially, with the interest rates of bank FDs falling, income funds provide an alternative low-risk, high-return option for investors. However, before you invest in income funds, keep in mind that these funds do not guarantee returns like bank FDs.

  • Income funds charge an expense ratio

Just like all mutual funds, income funds charge a fee for fund management. This fee is known as expense ratio, and the upper limit is fixed at 2.25%. You can overcome the setbacks of the expense ratio by staying invested for a long time. 

  • Ideal investment horizon is 1 to 3 years 

Income funds are suitable for investors who have an investment time period of 1 to 3 years. The perfect entry time is when interest rates are low and the exit time is when interest rates begin to rise. Instead of parking your surplus funds in an FD for a long time, you can invest them in an income fund to generate better returns.

  • Ideal for achieving short-term financial goals

The main objective of income funds is to supplement your regular income. It's an excellent choice to attain short-term investment goals like funding a child's higher education or paying the EMI of a home loan and so on.

  • High flexibility 

You can invest in income funds using a flexible SIP (Systematic Investment Plan). Also, there are several methods like STP (Systematic Transfer Plan) or SWP (Systematic Withdrawal Plan) for withdrawing units.

Taxation on Gains from Income Funds 

The taxes you pay on the gains you earn from income fund investments depend on how long you stay invested in it. Capital gains made within three years of investing are known as Short-term Capital Gains. STCG is added to the investor's taxable income and taxed as the individual's income tax slabs.

Gains made for three years is known as LTCG (Long-term Capital Gains). LTCG is taxed at the rate of 10% without indexation and 20% with indexation.

Best Performing Income Funds in India 

Here is a list of some of the top income funds in India. Make sure to analyse the fund on several parameters – historical returns, stability, expense ratio and more – to pick the right fund that best fits your financial objectives. 

S.No. Fund Name Risk Levels   1-Yr Return     3-Yr Return     5-Yr Return  
1          Aditya Birla Sun Life Treasury Optimizer Fund            Moderate 7.38 9.16 9.4
2 Axis Regular Saver Fund     Moderately High     6.78 8.49 8.7
3 BNB Paribas Flexi Debt Fund Moderate 6.71 8.3 8.22
4 Franklin India Corporate Debt Fund Moderate 6.79 8.52 8.79
5 HDFC Corporate Bond Fund Moderately Low 6.76 8.35 8.5
6 Kotak Corporate Bond Fund – Standard Plan   Moderately Low 6.35 8.27 8.19
7 SBI Regular Savings Fund Moderately Low 8.28 9.25 9.57

*Note that returns from these funds are subject to change based on market fluctuations. Make sure to choose funds based on your investment goals. 

Additional Reading : How To Choose The Best Mutual Fund?


Generate an Additional Stream of Revenue with Income Funds

Income funds provide investors with an excellent alternative to regular fixed deposits. If you are looking for a mutual fund that supplements your monthly income without high risks, then income funds are the right choice for you. Make sure to compare liquid funds and choose the right one that works best for your financial needs.