Types of income-generating assets

Income funds generally consist of a diverse array of income-generating assets, such as:

• Fixed income: government and corporate bonds offering predictable interest payments.
• Dividend-paying stocks: shares of companies that distribute a portion of their profits to shareholders, often mature and established businesses.
• Real Estate Investment Trusts (REITs): investments that generate income from a portfolio of real estate holdings.
• Preferred shares: hybrid investments with features of both bonds and stocks, commonly paying fixed dividends.
• Cash and equivalents: such as short-term GICs and HISAs.

Who are income funds suitable for?

Income investing can be a valuable strategy for a variety of investors, including:

• Retirees: those seeking a reliable income stream to cover living expenses.
• Risk-averse: individuals who prioritize stability and predictable cash flow over the potential for high growth.
• Long-term: beneficial at any stage, but particularly well-suited for those with a long-term investment horizon.
• Tax-focused: those that may prefer the tax treatment of dividend-paying stocks and certain bonds. 

Lastly, for some investors, regular income payments are attractive because they offer peace of mind, even if the overall growth potential may be lower.

Income fund volatility

Income funds are generally characterized by their lower risk profile. For example, investments in fixed income, short-term GICs, HISAs contribute to lower volatility. Furthermore, income funds tend to include dividend paying stocks from mature companies that have established cash flows and a successful long-term business, providing a dependable source of income. Over the long-term, typically spanning a decade or more, these investments tend to exhibit lower levels of volatility compared to more aggressive investments, making them more appealing for risk-averse investors.

Additional considerations and risks

Income funds can be sensitive to large interest-rate fluctuations—in either direction. For example, lowering interest rates can reduce GIC and HISA rates. In turn, higher interest rates could lead to a drop in bond prices and elevate credit (default) risk on certain corporate bonds.

The income distribution strategy may also not be sustainable—or may utilize income enhancement techniques—such as return of capital (ROC) distributions, leverage (using borrowed funds to amplify returns, at the cost of higher risk), or complex derivatives strategies like selling options. These enhancement techniques are more common for funds with higher income distribution levels. It’s prudent to assess income fund offering materials if funds promise higher distribution levels, as they may rely on these more complex techniques.

Conclusion 

Income funds cater to a diverse range of investors, such as retirees, risk averse and long-term investors. They can also be a valuable component of a well-diversified portfolio that includes growth-oriented investments. While income funds are traditionally associated with lower volatility, it’s important to recognize that they can be sensitive to large interest rate fluctuations, and not all income funds are created equally. The key is to find the right balance that aligns with your individual financial goals, risk tolerance, and time horizon. Consulting with a financial advisor can help you develop a personalized investment strategy that incorporates the benefits of income investing while also addressing your other financial needs.