Investors selecting an interest income fund, such as a bond mutual fund, consider factors such as return on bond holdings, potential changes in bond values, costs and fees, and tax implications. Income investing involves receiving periodic income payments, but total investment return may be affected by changes in bond values, fees, and taxes. Investors can choose investment grade corporate bonds, junk bonds, emerging market bonds, or bank loans for higher yields. The longer the maturity term, the more sensitive the market price is to interest rate changes. Management fees and tax exemptions on interest earned from municipal bonds are also important considerations.
When investors choose an interest income fund, such as a bond mutual fund, selection criteria may include the level of return on the fund’s bond holdings, any future changes in bond values, costs, and fees. of the fund and any tax effect on interest income. Income investing refers primarily to receiving periodic income payments. However, total investment return may be further affected by possible changes in the values of the underlying bonds in the fund, fees charged by fund administration, and taxes paid on interest earned.
Investors interested in income investing can choose an interest income fund that invests in investment grade corporate bonds that pay higher interest than the safest government debt yield while preserving investment capital. . Depending on individual investors’ risk tolerance, income investing may also target bond funds that invest in high-yield securities known as junk bonds. In exchange for higher interest income, investors have a higher risk of potential default.
Emerging market bonds and certain bank loans also pay higher yields than investment grade corporate bonds. An interest income fund that invests in emerging market bonds may be the choice for some income investors who are also looking to diversify into foreign markets. Some income funds might invest in a niche category of bank loans that pay higher yields comparable to junk-rated bonds but with specific assets as collateral. Another advantage of an interest income fund with bank loan holdings is that its interest is typically paid at a variable rate, which works best in a rising interest rate environment.
The value of an interest income fund likely fluctuates over time as the prices of the bonds in the fund change in response to changing market interest rates. A decrease in the value of the fund when investors sell their fund shares is equivalent to a loss of capital. This reduces the total return on investment despite a satisfactory level of interest income.
For rental securities, the longer their maturity terms, the more sensitive their market price will be to a change in the interest rate. This means that there would be a greater increase or decrease in price than that of securities with shorter maturities. In a market condition with a rising interest rate, for example, investors are better off investing in shorter-term bond funds whose value declines to a minimum when an interest rate increase causes all bonds to decline in value. .
Fund management fees should also be one of the main factors to consider when choosing an interest income fund. Income investing typically does not expect a high degree of capital appreciation compared to equity investing. Any additional charges from the fund would have to be absorbed directly by interest income, reducing the total return on investment. To increase investment returns, investors may also want to look for funds that have a portion of their holdings invested in certain municipal bonds, because the interest earned may be exempt from certain taxes.
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