Depending on their primary objective, most mutual funds can be divided into two groups: income or growth. There are funds that strive to provide both income and growth; however, one of the objectives usually is a dominant factor. This paper will focus on income mutual funds.
What Are Income Mutual Funds?
The primary objective of income mutual funds is to provide income—either maximum current income or tax-free income. Some income funds might have a secondary objective of capital growth. Therefore, income funds can contain stocks, bonds or a combination of both.
What Are The Different Types Of Income Mutual Funds?
Below are general descriptions of the primary types of income mutual funds:
Bond funds pay interest income from their debt securities. Because of changes in the market place, bond funds can experience some volatility. Interest rates are the main influence on bond prices. If interest rates rise, bond prices fall. If interest rates fall, bond prices rise. Bonds with maturity dates up to five years are considered short-term. Bonds with maturity dates from five to 12 years are considered mid-term. Bonds with maturities longer than 12 years are considered long-term. Some common bond funds are:
Corporate Bond Funds
These funds invest in bonds issued by various corporations. Income from these bonds is taxed at the federal and state income tax levels.
Municipal Bond Funds
These funds invest in bonds of municipalities. They will usually have the terms “municipal” or “tax-free” in their names. Investors in high tax brackets often favor muni-bonds because interest income is free from federal income tax, and in some cases, state or local taxes.
U.S. Government Funds
These funds hold U.S. Treasury bonds and/or bonds issued by government agencies, such as Government National Mortgage Association (GNMA), Federal National Mortgage Association (FNMA) and the Federal Home Loan Mortgage Corporation (FHLMC). Investors who purchase these funds usually want assurance of principal and interest payment.
Foreign Bond Funds
These funds purchase bonds issued in foreign currencies, such as the British pound. Generally, foreign currencies strengthen against the U.S. dollar, but if foreign currencies weaken against the U.S. dollar, it will be unfavorable to the U.S. investor. Of all bond funds, foreign bond funds have the highest expenses. We at Henssler Financial normally do not recommend foreign bond funds.
Strategic Income Bond Funds
These funds are sometimes known as multisector bond funds and typically invest in three types of bonds: foreign bonds, high-yield corporate bonds and U.S. government bonds. These bonds seek a high level of current income (and may also seek capital appreciation) while decreasing the volatility of the fund because each type of bond will be affected by different factors. At Henssler Financial, we normally do not recommend strategic income funds.
Equity Income Funds
Equity income funds invest in income producing common stocks. Some bonds and convertible preferred stocks might be found in these funds as well. Equity income funds usually invest in large, stable and well-established companies whose stocks pay relatively high and consistent dividends. These companies are usually in the energy, utility and banking industries. Younger companies tend to reinvest their profits back into the business. Equity income funds often invest in older companies that traditionally pay out profits to shareholders in the form of dividends.
As always, it is important that an investor understands individual funds can deviate from what is implied in the name, so be aware of such differences. It is also important that an investor closely reads the prospectus of any fund being considered and review any concerns with an adviser. For more information regarding this topic, please contact Henssler Financial at 770-429-9166 or [email protected].