You’ve probably heard the investment advice: “Make your money work for you.” But what does that actually mean when you’re not a City trader or a finance whizz? For many casual investors, it simply means finding a way to generate regular income from savings without needing a PhD in economics to understand what you’re doing.
Enter income funds—one of the more straightforward investment options that does exactly what it says on the tin. If you’ve got three minutes and a cup of tea, let’s demystify what income funds are, how they work, and whether they might suit your financial goals.
What Actually Is an Income Fund?
An income fund is an investment fund specifically designed to generate regular income for investors, typically paid quarterly or monthly. Think of it as a basket of investments—shares, bonds, or property—chosen because they produce steady income through dividends, interest payments, or rent.
The key distinction is intent. Whilst some investments focus primarily on growing your capital over time (growth funds), income funds prioritise delivering regular cash payments whilst still aiming for some capital growth. It’s the investment equivalent of choosing a fruit tree that produces apples every season rather than one you’re planting purely to sell for timber decades later.
When you invest in an income fund, your money is pooled with other investors’ money. A professional fund manager then invests this collective pot into income-generating assets. The income produced is distributed to investors proportionally based on how much they’ve invested.
The Three Main Flavours
Income funds typically invest in three main types of assets, each with different risk and return characteristics.
Equity income funds invest primarily in company shares that pay regular dividends. These are typically established, profitable companies—think utilities, banks, consumer goods manufacturers—that distribute a portion of their profits to shareholders. The income potential is attractive, and there’s scope for capital growth, but share prices can be volatile. Your capital isn’t guaranteed.
Bond income funds invest in government or corporate bonds—essentially IOUs where you lend money in exchange for regular interest payments. Government bonds (gilts in the UK) are generally lower risk but offer lower returns. Corporate bonds pay more but carry the risk that companies might default. Bond funds are typically less volatile than equity funds, making them popular with cautious investors.
Property income funds invest in commercial property—office buildings, shopping centres, warehouses—and distribute the rental income to investors. They offer diversification away from traditional shares and bonds, though property can be less liquid. During market stress, you might face delays accessing your money as funds manage redemption requests.
Many income funds are “multi-asset,” blending these different investment types to balance risk and return. This diversification means you’re not overly exposed to problems in any single sector or asset class.
Why Bother with Income Funds?
The appeal of income funds varies depending on your circumstances and what you’re trying to achieve.
If you’re retired or approaching retirement, regular income matters. You might need to supplement your pension or create income streams to replace your salary. Income funds can provide this without requiring you to constantly sell investments (which erodes your capital and creates hassle).
Even if you’re younger and still working, income funds offer advantages. That regular income can be reinvested automatically, buying more units of the fund and compounding your returns over time. It’s a more hands-off approach than constantly monitoring growth stocks and trying to time when to sell.
Income funds also provide diversification without complexity. Instead of researching and buying individual dividend-paying shares or bonds yourself, you access a professionally managed portfolio of potentially hundreds of investments through a single fund. The minimum investment is usually modest—often just a few hundred pounds—making diversification accessible.
There’s a psychological benefit too. Seeing regular income arriving in your account feels tangible. You can track what your investment is “doing” beyond just watching the capital value fluctuate. For many investors, this makes the whole experience less abstract and anxiety-inducing.
The Reality Check: What Income Funds Aren’t
Before you rush off to invest your life savings, let’s be clear about what income funds aren’t.
They’re not savings accounts. Your capital isn’t guaranteed. The value of your investment can fall as well as rise. During market downturns, your fund value will likely drop, sometimes significantly. Yes, you might still receive income payments, but if you need to withdraw your capital during a slump, you could crystallise losses.
They’re not immune to cuts. The income you receive isn’t fixed. Companies can reduce or suspend dividends during tough times. Bond issuers can default. Property rental income can fall. Fund managers often try to smooth distributions, but there’s no guarantee your income won’t decrease.
They’re not tax-free (usually). Income from funds held outside tax-advantaged wrappers like ISAs or pensions is subject to income tax. Dividends have a small tax-free allowance, but beyond that, you’ll pay tax based on your income tax bracket. This can significantly impact your actual returns, especially for higher earners.
They come with charges. Fund managers aren’t running these funds out of charity. Annual management charges typically range from 0.5% to 1.5% or more. Over decades, these fees compound and can substantially reduce your overall returns. Always check the total ongoing charges before investing.
How to Actually Invest in Income Funds
Investing in income funds is straightforward. You’ll need to open an account with an investment platform—essentially the middleman between you and the fund. Popular UK platforms include Hargreaves Lansdown, AJ Bell, Vanguard, and Interactive Investor, among others.
Each platform has its own fee structure. Some charge percentage-based fees on your portfolio value, others flat fees, and some a combination. For smaller portfolios, percentage fees might work out cheaper; for larger holdings, flat fees often win. Do the maths for your specific situation.
Once you’ve chosen a platform, you’ll need to decide whether to hold your investment in an ISA (tax-free but subject to annual contribution limits—£20,000 for 2024/25), a pension (tax relief on contributions but money locked until retirement), or a general investment account (fully flexible but income is taxable).
Then comes choosing your actual fund. Most platforms offer tools to filter funds by type, risk rating, performance history, and charges. Don’t just chase the highest income yield—a 7% yield might look attractive, but if it’s achieved through high-risk investments or by eroding capital, it’s not necessarily better than a 4% yield from a more sustainable strategy.
Look at the fund’s track record (though remember past performance doesn’t guarantee future returns), understand what it actually invests in, check the charges, and read the fund factsheet. If you’re uncertain, many platforms offer ready-made portfolios designed for income investors at different risk levels.
When Income Funds Make Sense (And When They Don’t)
Income funds work brilliantly for investors who want regular, relatively passive income without the complexity of building and managing their own portfolio of individual investments. They’re particularly suited to retirees supplementing pensions, or investors who prefer tangible returns over purely hoping for capital appreciation.
They’re less ideal if you’re young with decades until retirement and don’t need income now. In that scenario, growth-focused funds that reinvest all returns might deliver better long-term results. The income payments from income funds, even if reinvested, can be less tax-efficient than funds that automatically reinvest internally.
Income funds also aren’t suitable if you need guaranteed capital preservation. If you might need your money back within five years, or if you can’t stomach seeing your investment value fluctuate, income funds probably aren’t right for you. Stick with savings accounts, even if the returns are modest.
The Bottom Line
Income funds aren’t complicated, despite the financial industry’s best efforts to make them seem so. They’re simply investment funds that prioritise generating regular income whilst aiming for some capital growth. They invest in dividends from shares, interest from bonds, or rent from property, and pass that income to you.
For casual investors seeking passive income without becoming investment obsessives, income funds offer a sensible middle ground between leaving money in low-interest savings accounts and trying to build a complex investment portfolio yourself.
The key is understanding they’re not risk-free, choosing funds with reasonable charges, holding them in tax-efficient wrappers where possible, and having realistic expectations about what they can deliver. Do that, and income funds can become a valuable part of your financial toolkit—generating regular income whilst you get on with actually living your life.
Three minutes up. Now you know enough about income funds to decide whether they deserve a place in your investment strategy.
