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What are income mutual funds?

Here is an in-depth guide to income mutual funds, their benefits, risks, and returns. Click to learn more!

Of late, mutual funds have found favour with a broad spectrum of investors in India. Several kinds of mutual fund schemes have been created over a number of years, catering to a variety of investor needs. If you want to succeed in your investing journey, you must thoroughly educate yourself on the types of investment channels available and how they suit your own financial purpose. Among the diaspora of investment instruments, and falling within the category of mutual fund investments, are income mutual funds. 

Income mutual funds are a form of debt funds. They invest in instruments of debt, such as government securities, debentures and corporate bonds, among others, for an extended period. Income mutual funds are classified by SEBI, the Securities and Exchange Board of India as debt funds that have a Macaulay Duration of 4 years or above that. Aligned with this classification, there are two kinds of debt funds that exist under income mutual funds. 

Types of Income Mutual Funds

The Macaulay Duration represents the weighted average tenure to maturity, of cash flows arising out of a bond. Therefore, according to SEBI’s classification of funds that make up income mutual funds, two types are offered to investors. These are highlighted below: 

  1. Long Duration Income Mutual Funds - According to the criteria of the Macaulay Duration, these funds have a term of above 7 years. 
  2. Medium to Long Duration Income Mutual Funds - According to the criteria of the Macaulay Duration, these funds have a term of 4 to 7 years. 

Advantages of Income Mutual Funds

The advantages of investments in income mutual funds are explained below: 

  • Increased Liquidity - Income mutual funds have no lock-in periods that are characteristic of other fixed income instruments like fixed deposits, in which penalties are charged for premature capital withdrawal. 
  • Alternative to Traditional Instruments - Traditional instruments like fixed deposits may not offer you as high returns as compared to income mutual funds. 
  • Taxation Advantages - In case you fall within the highest tax slab (30%), your investments in income mutual funds offer you benefits of taxation. 

Disadvantages of Income Mutual Funds

There are some disadvantages to investing in income mutual funds, although the risks are not as high as you would face with equity mutual funds. Still, here are some disadvantages to investing in income mutual funds: 

  • Exit loads - Income mutual funds may not come with any lock-in periods that stringently force you to remain invested, or charge any fees for withdrawal of your capital before the end of a tenure. However, there are some income funds that have inherent exit loads if you withdraw from the funds before the end of their tenure. These exit loads vary from one fund to the next, so you should check fees and charges before investing. 
  • Taxation - While you get certain tax benefits, these are only up to certain limited amounts. If you fall in the highest tax slab (30%), you have to pay tax of 20% as long-term capital gains (LTCG) on income mutual funds. 
  • Certain Risks - A credit risk and an interest risk is tied to any debt fund you invest in. The credit risk involves the failure of the issuer to repay the interest along with the principal. Furthermore, any change in interest rates has an impact on the value of securities in the fund. 

How Income Mutual Funds Work

An income mutual fund, just like any other mutual fund, is operated by a fund manager. The fund manager aims to deliver positive returns on the fund, regardless of interest rates fluctuating. This is primarily done by effective management of the portfolio of the fund. Two main strategies are employed by fund managers to make income mutual funds work optimally: 

  • The Generation of Income - This is achieved by fund managers when funds hold debt instruments up to the date of maturity (for the long term).
  • Gainful Earnings - These are achieved in income mutual funds when fund managers seize opportunities to sell debt instruments when their prices rise. 

How to Invest in Income Mutual Funds

Income mutual funds allow you to invest minimal amounts so you can get a hang of investment if you are a novice. Just like you invest in any mutual funds, whether they invest your money in equity or debt, you can easily directly invest online, or go through the route of an agent. You should note that agents charge you a commission for their services and you may end up spending more than you invest initially. The direct path to investment in income mutual funds is a better way, and you can do this by logging on to the website of the fund. Several banks also offer you the services of mutual fund investing through their investment banking divisions. The way to start is by doing some research on different funds, and determine which ones meet your unique financial requirements. 

When are income mutual funds paid to investors?

Depending on the kind of instrument the income mutual fund invests in, returns are paid to investors in the form of interest. For instance, bonds bear interest which is paid out to investors. All net income, such as interest earned on treasury bills or government bonds, must be passed on to investors by income mutual funds. Typically, if an income mutual fund invests in bonds, a fixed rate of interest is paid out to investors once a year. The payout is actually a percentage of the face value of the bond. Unlike dividends from stocks, bond returns in the form of interest are guaranteed. Therefore, when you invest in income mutual funds, the amount of interest will be established upfront. 

Tax Implications of Income Mutual Funds

The tax implications for your income mutual fund depend largely on the holding period of the fund in question, and the tax slab you fall within according to the Indian Income Tax Act. As there are two kinds of returns you get on debt funds, such as income from interest and capital appreciation of the fund’s value due to market value changes, you are taxed accordingly. Income mutual funds are held for a period of four years or more, in general, so a tax of capital gains is applicable. In case you withdraw from the fund of your own choice before a period of three years, a short-term capital gains tax is levied according to your taxable income slab. If you hold your income mutual fund investment  for more than three years, the long-term capital gains tax applies to the interest earned on your investment. 


  1. Is an income mutual fund investment less risky than a mutual fund that invests in equity?

It is a less risky form of investment than investments in equity as it guarantees you fixed returns in some funds, like those that invest in government bonds. 

  1. Does an income mutual fund help me to plan for retirement?

An income mutual fund can definitely help you to plan for your retirement, with minimal risk involved. An income mutual fund investment mitigates your risk and helps you diversify your portfolio. Since this is a long-term plan for gaining returns, you can reap rewards that help build a retirement corpus. 

  1. Can I invest my wealth in an income mutual fund and in a fund that is linked to equity?

You can do this. In fact, if you invest in a hybrid mutual fund, you get the benefit of investing a portion of your capital in debt and another in equity. 

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