Summary - Risk management is one of the fundamental objectives of any investor and financial professional. There are trillions of dollars in employee-sponsored 401(k) plans with the vast majority of that money allocated to mutual funds and exchange-traded funds (ETFs). However, different funds have different objectives. Some of the most common classifications for mutual funds are growth, growth and income, and income. Each of these has a different purpose.
Growth funds focus on aggressive growth that will exceed a market index. They offer a high level of risk for the potential of a large return. These funds do not focus on dividend stocks or bonds.
Index funds focus on fixed-income securities with the idea of generating income while preserving the principal and capital gains that an investor has achieved. While being very low risk, these funds also offer very little hope for capital gains.
Growth and income funds represent the “Goldilocks” approach that fits investors of all ages. These funds take on a two-pronged objective. The first is to generate capital gains through stocks and other equity instruments that have a chance for moderate growth, frequently tied to a stock market index. The other objective is to generate income. This is done by investing in income-generating bonds as well as stocks that pay dividends.
Growth and income fund investors are not categorized by a specific demographic but rather by investment objective and risk tolerance. Like all investments, growth and income fund investors should carefully study the fund’s prospectus for information about fees and sales charges that could impact a fund’s total return.
A well-executed investment strategy is built on both the present and the future. Just as a young professional may have reason to believe their earnings (and therefore the money they have available to invest) may increase as they reach their 30s and 40s. So too will their risk aversion when it comes to their existing investments – particularly the money they’ve set aside for retirement.
Investors, in general, move through three broad phases. The first and third phases represent the two extremes of investing. The first phase is aggressive growth. This is a period where their income is increasing and they are looking to build the size of their investment portfolio as quickly as they can. The aggressive investor is willing to trade more downside risk for the potential of a large return. These investors may even welcome volatility in the stock market because it means the potential for larger movement in the assets in which they are investing.
The third phase is marked by a move towards security. Investors usually reach this stage when they are at, or near, retirement. Investors in this stage of their retirement plan typically look to invest in fixed-income securities such as fixed-income funds that put a premium on capital preservation with the opportunity for regular income, typically through dividends.
Between these two phases is, perhaps, the most challenging phase for investors. The middle phase is the transition between aggressive growth and low growth and income. This “balanced” period is marked by a move towards stocks and mutual funds that walk a fine line between offering the opportunity for capital appreciation and the ability to generate income that will allow them to “bank” some of the capital gains they have achieved.
For mutual fund investors, one of the popular instruments to work through this second phase of investing is the growth and income fund. In this article, we’ll break down the growth and income fund, how investors should choose a fund,
What is a growth and income fund?
A growth and income fund is either a mutual fund or exchange-traded fund (ETF) that, as the name states, attempts to simultaneously achieve two goals for shareholders. The first is to achieve capital appreciation by investing in growth stocks. Growth stock funds include stocks of companies who are expected to grow faster than the overall stock market or a corresponding index, such as the S&P 500 Index. Income funds, which are alternately referred to as value funds, seek to provide investors with a source of income through dividends. The goal of income stocks is to find companies that are undervalued.
The income part of a growth and income fund is not limited to dividend stocks. It can also include other assets such as bonds that tend to move in the opposite direction from stocks. This protects investors because their goal is to achieve modest growth without the extremes that are found with aggressive growth investors.
What are the tax implications of a growth and income fund?
The tax implications associated with a growth and income fund are no different than other mutual funds. Short-term capital gains (meaning funds that are held for one year or less) are taxed as ordinary income at the shareholder’s marginal tax rate. Long-term capital gains receive the more favorable capital gains rate.
What are some characteristics of the growth and income investor?
The growth and income investor is not a demographic. However, growth and income-oriented investors share important characteristics. First, they have a moderate risk tolerance. This is one reason why a growth and income fund is called a balanced fund. It balances risk and reward. These funds may lag behind traditional growth funds during a bull market. However, when market conditions are less favorable, these funds offer the stability that can lead to superior performance.
Another characteristic of the growth and income investor is that their time horizon. The objective of a balanced fund is to get stable growth that can outpace inflation without taking on excessive risk. Sound investment management dictates that the closer an investor is to retirement the lower the risk in their portfolio. A young professional who could withstand the potential risks of a market correction may have a lower tolerance for volatility and choose the stability offered by a growth and income fund. This, however, does not mean they will be in the same fund as a 50-year old who has a much shorter timeline. This is one of the benefits of a growth and income fund. With so many options, investors can find one that is tailored to their needs both now and in the future.
What is the benefit of a growth and income fund to retirees?
A growth and income fund can still be part of an investment strategy in retirement. As investors move out of the workplace, they are looking for a way to replace their income with income-producing securities such as large-cap stocks that pay a dividend and bonds. Many growth and income funds hold a substantial amount of government bonds and investment-grade bonds that offer semi-annual interest payments. This ability to get reliable income both from equity instruments as well as bonds can help a retiree ensure that they will not outlive their retirement savings. In fact, financial advisors recommend that retirees replace 75% of the income they will need in retirement with the income they can receive from such funds.
How to select a growth and income fund
There are hundreds of funds that fit the growth and income fund category. Very few growth and income funds are 50% growth and 50% income. Funds may be weighted 70/30 or 60/40 in favor of growth. Others could be more focused on the income side. Some of these funds are tied to an index. This means that the performance of the fund is closely matched to a specific index.
With that in mind, it’s important to understand what type of considerations investors need to make when choosing a growth and income fund.
One of the first pieces of investment advice for shareholders when selecting a growth and income fund is to read the prospectus that is released by every fund such as Vanguard, Fidelity or American Funds. This prospectus is usually provided on the website for a particular fund family. Some of the questions that investors should be able to answer by looking at the prospectus are:
- What is the objective of the fund is and how does the fund goes about achieving the objective?
- What is the fund’s asset allocation? A growth and income fund is sometimes referred to as a diversified fund. However, diversification includes not only diversity among assets, but also diversity within a particular asset class.
- What are the fees and expenses associated with the fund? This includes not only the operating expenses but also any expense reimbursements, also called expense waivers or expense offsets offset, that the fund absorbs to keep their net (actual) expenses low. In many cases, expense reimbursements are voluntary but are sometimes a contractual obligation.
- Does the fund include a sales charge (known as a load) and how much is it?
- Are these actively managed funds or passively managed funds? Actively managed funds will have higher fees associated with the portfolio manager who actively selects securities with a goal of outperforming a market index. A passively managed fund will still have a portfolio manager, but they are selecting securities with the intention of closely mirroring an index. In this sense, there will be lower fees and expenses for this category. In many cases, investors may achieve a higher total return by choosing a passively managed fund that lowers the overall operating expenses.
Morningstar is a company that offers ratings for all categories of mutual funds. A Morningstar rating carries weight with asset managers, portfolio managers, and institutional investors.
What are the top rated growth and income funds?
Currently, here are the top 10 growth and income ETFs according to The Street.
- Shares Convertible Bond (ICVT)
- SPDR Russell 1000 Low Vol Focus
- Global X Guru Index ETF
- Schwab US Dividend Equity ETF
- SPDR Bbg Barclays Conv Sec ETF
- Invesco China Real Estate
- First Trust Value Line Dividend
- WisdomTree US LargeCap Dividend
- Vanguard Tot Stk Mkt Idx ETF
- Nuveen Short Term REIT
This list brings up an important point about growth and income funds. While typically associated with securities such as stocks and bonds, these funds can include assets such as real estate investment trust (REIT) stocks and, as noted above, can be tied to an index.
The bottom line on growth and income funds
Growth and income funds can be an ideal investment vehicle for investors who have a moderate risk appetite yet still want the potential growth that comes from equity funds. For these investors, a growth and income fund represent the best of both worlds. Shareholders can receive a reliable source of income through both common stocks that pay dividends and bonds that pay regular interest. However, they will also enjoy the opportunity for capital gains growth as the underlying stocks appreciate over time.
There is no one size fits all when it comes to growth and income funds. Although they are frequently called balanced funds, the composition of the fund is very rarely 50 percent growth and 50 percent income. In most cases, the fund’s composition is skewed based on an investor’s growth objectives and investment timeline.
One of the most important tools for a mutual fund investor is the prospectus that is issued by every fund. Within the prospectus, there are critical details regarding a fund's objective, their fee, and expense structure, whether they have a sales charge (load), their asset allocation and whether they are actively or passively managed.
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