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Low interest rates to keep income funds in demand

Interest rates are unlikely to rise anytime soon.

A 16-day partial government shutdown that ended Oct. 17 knocked consumer confidence. All told, it took about $24 billion dollars out of the economy, according to Standard & Poor's.

The shutdown began two weeks after the Federal Reserve surprised financial markets when it said that it would continue buying $85 billion of bonds every month to hold down long-term interest rates until the economic recovery was more entrenched.

The nomination of Janet Yellen as the next Federal Reserve chair also suggests that the U.S. central bank may err toward keeping rates low. Yellen is widely seen as a "dove" on Fed policy because she stresses the need to boost growth and reduce unemployment, rather than worry about igniting future inflation.

Even after four years of ultra-low interest rates and extraordinary monetary stimulus, analysts don't expect rate increases to start until at least the middle of 2015.

Although rates close to zero may help boost the economy, they're bad news for savers who need an investment income to cover their expenses. Investors seeking to achieve the steady returns that used to be typically available on savings products now have to look elsewhere.

Income funds, which often consist of a mix of bonds and stocks that pay large dividends, are one way for investors to achieve a similar return.

Linda Bakhshian, who manages Federated Investors' Capital Income Fund, says that demand for income funds is also being bolstered by an aging population and, as retirees live longer, each investment dollar has to stretch further. The fund seeks to provide a monthly payment for its investors through a portfolio that's split evenly between bonds and stocks.

Q: With the Standard & Poor's 500 posting double-digits returns in four of the last five years, why should investors buy into an income fund, rather than just invest in a traditional stock fund?

A: What income funds essentially do is allow you to participate in the capital appreciation of the market over the longer term but, they minimize the volatility and the downside of your portfolio.

Think about the roller coaster that equities go on, on a yearly basis. Income funds give you a smoother ride through that market cycle. They end up in the same place but with less volatility, while generating income on a monthly basis.

You also need to think about taxes. Dividends have a lower tax rate than capital gains taxes. If you just want to be 100 percent in the stock market and you want to pay a bill, then you may have to sell a stock. Whereas, with a dividend income fund, you get monthly income and your taxes are lower.

Q: What type of stocks does your fund invest in?

A: We are invested across all the S&P 500 sectors, for example we own consumer discretionary stocks, industrials and a little bit of technology stock. We also own financial stocks.

About 14 percent of the fund is in international equities. International companies are a little bit more dividend friendly than historically U.S. companies have been because U.S. companies do generally consider share buybacks in addition to dividends.

About nine percent of the fund is in convertible bonds (which can be converted into stock if the stock rises to a certain level).

Q: Have company attitudes about dividend payments changed in recent years?

A: Dividends have really come back into vogue over the last 10 years, or so. If you look back over the 1980s, or the 1990s, dividends were essentially out of favor. Any company that paid a dividend was considered a company that had limited growth and didn't know what else to do with the cash, other than give it back to its shareholders.

Investors are now asking for that dividend essentially to get some income from companies. This also imposes some shareholder discipline on management.

Q: At what age should people start considering investing in an income fund?

A: Anywhere after the age of 40, people should start to look at income funds. As a source of monthly income or to reinvest that income. Income investing should be part of your portfolio; if you're younger you get that income and you re-invest it. If you're older you can take some of the cash and pay your bills with it.

Income investing should be part of your whole investing life cycle, it's just a matter how much you allocate to it. When you're younger you should allocate a little bit less, when you're older you should allocate a bit more.

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