What are benefits of a growth and income fund?

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.

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Introduction

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,

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.

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.