A three-minute guide to income funds

Everyone loves a little extra income. Whether it’s to help cover the monthly bills, pay for luxury holidays, or simply improving our quality of life. It’s particularly useful given how interest rates on bank savings accounts have fallen over the past few months – despite living costs remaining high.

One way to create a steady income stream from your investments is through an income fund. If you’re new to investing, don’t worry — here’s a simple explanation of how they work, who they’re suitable for, and how to pick one.

What are income funds?

An income fund is a type of investment that aims to pay you a regular income, usually every month or every quarter.

These funds generate cash by:

• Collecting dividends from shares (profits paid out by companies),
• Earning interest from bonds (loans to governments or corporations),
• Or through rental income from property investments.

Unlike funds that focus on “growth” — where the goal is to grow the value of your investment over time — income funds are designed to put cash directly in your pocket on a regular basis.

Types of income funds

There are different types of income fund. Some invest in a company’s equity, some in its debt. Others embrace different asset classes in the same portfolio.

Here are some of the most common:

• • UK equity income funds: Invest in UK-listed companies that pay their shareholders a regular and rising income. These will usually be large, established firms.

• • Global income funds: These still focus on dividend payers but they can scour the globe for the best opportunities. This gives the manager a better choice.

• • Fixed income funds: They can hold hundreds of government or corporate bonds. Each of these will pay a regular amount of interest. The fund will then distribute this to its investors.

• • Property funds: Portfolios will invest in physical properties such as offices, warehouses and retail units. They receive rent from tenants. The value of the buildings will also hopefully rise.

• • Multi-asset income funds: An attractive option for investors wanting diversification. These funds will generally hold a mix of equities, bonds and property assets. This gives them different sources of income.

Who buys income funds?

Income funds are popular with people who want a steady, reliable income stream, including:

• • Approaching retirement: Someone nearing – or already in – retirement may need their investment pots to start working on their behalf to supplement their pensions.

• • Wanting diversification: Investors who already have assets in growth-oriented assets may want to de-risk their overall portfolios. In that case, income seeking makes sense.

• • Generating a passive income: The regular payments can tick the box for anyone wanting a bit of extra money to help pay the bills or pay for life’s little luxuries.

Who might they not suit?

While equity income funds can be a useful tool for many investors, they might not suit those who are unable or unwilling to take on equity risk. Since many income funds invest in shares, their capital value can rise and fall with the stock market. If you need absolute capital stability — perhaps for very short-term needs — income funds might not be the right solution.

However, for investors who don’t currently need the income but still want exposure to dividend-paying companies, there’s an alternative: you can choose to buy “accumulation” units rather than “income” units. This way, any dividends or interest the fund earns are automatically reinvested back into the fund, helping grow your overall investment over time.

Other types of income, such as fixed income or property, might not be suitable for younger investors aiming to grow their wealth aggressively. Additionally, risk-takers comfortable with market ups and downs may find fixed income funds too “safe.”

How to choose an income fund

There are thousands of funds available – and many of them are potentially suitable for income investors. So, how do you choose?

You will need to base it on the following:

• • Your income needs: How much do you need to make each year? Is this needed to cover existing commitments or are you looking for some extra fun money?
  • Existing holdings: Do you have other sources of income in place? If so, it makes sense to consider diversifying away from these existing positions.
  • Risk appetite: How much risk are you willing to take? Do you want a portfolio that invests in smaller companies or emerging areas – or do you prefer established, larger-cap names?
  • Asset allocation: Do you want exposure to particular assets or geographical locations? Where do you want your money invested?
  • The manager’s track record: Past performance is no guarantee of future returns but it’s still worth finding a manager that has been able to deliver in different market conditions.

Final thoughts

Income funds can be a smart way to turn your investments into a regular paycheque, especially in a low-interest-rate environment. But as with any investment, it’s important to align your choices with your personal goals, income needs, and attitude to risk.