I am an extreme proponent of monthly income funds because they perfectly fit the Monthly Cashflow Analysis. I like this kind of investment so much that about 1/3 of my wealth is in such funds. If I have extra cash and don't see any opportunity, this is the "catch-all" investment vehicle. I dump everything in here, wait for a price crash somewhere, analyse to see if the market overreacted and carve out a chunk of cash from the monthly income funds to buy up the cheap asset to hold long term.
What are Monthly Income Funds?
Funds, in general, are a pool of money from individual investors like us entrusting our money to a group of fund managers to make investment decisions on our behalf. Depending on what fund you are investing, their strategies and the method of realising your profits can be drastically different. As the name suggests, Monthly Income Funds strive to pay back the investors with monthly fixed income. In other words, if you invest in these funds, you will be paid money every month as if you have a second job on the side, except you don't actually work. There is only one way for these fund managers to achieve this, and that is by taking all the invested money and loaning them out to a diverse set of companies to collect regular repayments with interest. If they were to invest in things like stocks for capital gains, the returns on these are too unreliable to be able to pay back the investors with regular monthly fixed income.
The goal of the Monthly Income Funds is:
- Generate consistent monthly income
- Provide access to a wide range of credit investments. Credit investments here mean the fund managers are loaning our money out.
- Maintain or increase Net Asset Value per share over time. The fund's overall value will increase if the managers do an excellent job loaning to the right companies who will properly pay the loans with high-interest rates. This results in your shares rising in price, and there are some unintended capital gains there to be your profits.
What are Closed-End Income Funds?
The closed-end funds are a particular type of funds among the monthly income funds. While open-ended funds create new shares as more money comes in from investors or dissolve them as investors pull out, a closed-end fund produces a finite number of shares at the start. You can still buy and sell the shares on the open stock exchange between the investors, but outstanding shares remain constant. From the fund manager's perspective, because the investors only buy and sell the shares amongst themselves and never really pull the money out of the fund's money pool, they don't ever have to worry about pulling money out of their investments to give back the money to the investors. This means they can afford to invest in more risky and illiquid things. Taking on more risks can result in greater profits if played right. In the case of monthly income funds managers, they will lend money to more risky companies at a much higher interest rate or even leverage to lend money (borrow at a cheaper interest rate to lend at a higher interest rate).
Pros / Cons of Monthly Income Funds
- It pays you a monthly income that becomes an additional income stream in the Monthly Cashflow Analysis. Reinvesting to buy more shares of these will result in a compounding effect that gives you exponentially more monthly income over many years. Worth holding onto for a lifetime.
- Loans are usually made out to companies, and if they are to go bankrupt and liquidate their assets, loans are paid off as a high priority before the shareholders.
- The share prices of such credit-based income funds are less volatile, and they are not likely to go down as much as the growth stocks during the recession.
- The most significant downside is that their share prices don't move much. There are minimal capital gains, or none, to be made when other growth stock prices can skyrocket during good economic times.
- These are the less popular shares in the stock market. Everybody wants to make quick and easy money with growth stocks like Tesla. The shares for income funds can be illiquid, although you would have to be dealing in millions to start seeing the significant effect.
What Monthly Income Funds to buy in the UK?
I diversify my investments into two Monthly Income Funds.
- NBMI (6-7% annual return, at the time of this writing)
- SMIF (7-8% annual return, at the time of this writing)
Both are closed-end funds, and thus they can be pretty illiquid; therefore, it's not ideal for short-term in and out trades. These are for long-term investments, if not for a lifetime.