Many people need additional monthly income. For example, retirees may need to augment Social Security payments. For these people, mutual funds that produce a steady income stream may help satisfy this need. Depending upon the nature of the fund, such investments can increase monthly income while simultaneously preserving capital.
Funds that produce monthly income are loosely classified as "growth and income funds" or "income funds." Growth and income funds invest in securities with high potential for growth, and in dividend-paying securities for income. Sometimes they are categorized as "managed payout funds" or "replacement funds." Some funds, such as Vanguard Managed Payout Fund and the Fidelty Income Replacement Funds, determine a monthly payout a year in advance so that the monthly payout does not vary from month to month.
The portfolio of a fund that pays monthly dividends generally falls into one of several categories. Mutual funds that pay monthly income include money market funds, U.S. bond funds, and international bond funds. U.S. bond funds includes funds that may invest in corporate bonds, mortgage-backed securities, U.S. treasuries and municipal funds.
Mutual funds send you a 1099-DIV or a similar document before January 31 that accounts for the funds that have been paid out. Income from a mutual fund must be reported to the Internal Revenue Service, even if it was immediately reinvested. Whether the income is taxable depends upon whether the fund has invested, wholly or partially, in tax-exempt securities. Fund distributions are reported using a form 1040 or 1040A. Filing a Schedule B might also be necessary. A 1040EZ cannot be used to report mutual fund income.
Morningstar characterizes money market funds and funds that invest primarily in U.S. Treasuries as very conservative investments. Moneyrates.com reports that "only twice in 40 years did the value of a money market fund decline below the amount invested." While these analysts view such investments as safe, these funds continue to be subject to the whims of the market. A January 2013 article appearing in the Wall Street Journal lamented the effect of falling interest rates on income funds, which in turn result in lower income for investors.
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- IRS: Publication 550 - Investment Income
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- Vanguard: Vanguard Managed Payout Funds
- Wall Street Journal: It Isn't Any Easier for Income Investors
- Janus: Janus Growth & Income Fund
- Fidelity: Fidelity Income Replacement Funds
- Morningstar: Where to Put the Emergency Fund
- MoneyRates.com: Money Market Accounts vs. Money Market Funds
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