Types of income funds
Fixed income funds
Money market funds are considered near-cash investments and are the most conservative types of income funds. They invest in highly liquid securities such as Treasury bills and other high quality short-term securities. The yield is typically very low. The income generated from a money market fund is unlikely to keep pace with inflation.
Bond funds seek higher levels of income. They can contain all types of bonds:
- Government - domestic (federal, provincial, municipal) and global, including emerging market sovereign debt
- Corporate - domestic and global, including emerging markets. Investment grade and sub-investment grade, also known as “high yield” (formerly referred to as “junk”)
Yield versus income
Yield is an approximate measure of return on investment, normally expressed as a percentage.
Income is the money received through investment of capital, normally expressed in dollars.
A fund that invests in high-quality government bonds would be considered conservative, while a fund that invests in below-investment grade bonds issued by corporations thought to be at risk of default would be considered aggressive.
When considering a bond fund it’s important to be aware of the various risks, including interest rate risk, credit risk and inflation risk. It’s important to always read a fund’s simplified prospectus to understand these potential risks before investing.
Equity income funds
Equities offer a different type of income: dividends. A dividend is a portion of corporate earnings paid out to shareholders.
Not all corporations pay dividends; some may choose to reinvest earnings to further grow their business. Investing in a fund containing dividend-paying equities generally means you’re investing in mature, stable companies that often weather economic turmoil better than less established firms. Though there is some growth potential associated with dividend-paying equities, it tends to be less than what’s offered by earlier stage companies typically held by equity growth funds.
Equity income funds might invest in preferred shares. Their dividends are more secure than those paid on common shares. Preferred shares offer more protection than common shares, though they tend to have lower growth potential.
Diversified income funds
Diversified income funds contain a mix of income-producing securities. In this respect diversified income funds offer a kind of one-stop shop. Various investment needs may be met, while the diversified asset base can help reduce risk:
- Money market securities
- Mutual funds
- Government bonds
- Corporate bonds
- Preferred shares
- Dividend-paying common shares
- Real estate investment trusts
Diversification plays a critical role. Certain asset classes will do well under certain market conditions, while others may do poorly. As market conditions inevitably change, the asset classes switch roles. The aim is to provide consistent investment returns with lower volatility.