Why Fixed Maturities Plans scores over Fixed Deposits
When it comes to investing, both FMPs and FDs gives more or less the same returns. However when compared in real term, the difference between the two is substantial. Financial advisor Anil Rego discusses the advantages that FMPs enjoy over FDs.
Amit Gobind is no pushover when it comes to investing in smart products. A keen reader of financial publications and an observer of swinging market indices, the 38-year old banking executive took pride in most of his investment decisions until the time someone asked if he had invested in the latest Fixed Maturity Plans or FMPs. He had just shifted bulk of his investments into term deposits to avoid market shocks despite knowing well that his tax liability would go up. Soon, a flurry of FMP launches happened and put Amit in a quandary - did he miss something here?
Let us explore FMPs and their fundamental differences with FDs.
FMPs typically take advantage of high interest rates prevailing in an economy; hence most funds make loud noises when the situation is conducive, as is the case at present. These plans come with an average tenor of 1-2 years while a few are in the range of 1-3 months as well. Generally considered safe, FMPs are attractive for individuals in the highest tax bracket of 30.90% since the tax rate is just 10.30% if one stays invested for at least a year. A growth plan is an ideal option for plans with a year or more whereas for less than that, one can prefer dividend route as dividends are tax free (after a distribution tax of 15%).
FMPs are debt schemes of a close-ended nature with investments in CDs (Certificate of Deposits) and commercial papers issued by companies (spanning three months to one year or a maximum of two years). So fund allocation is also in debt securities that have similar maturity plan (one year plan invests in securities of one year tenure). On maturity, the fund will exit the instrument and investors can redeem their investments. Though FMPs seem to have plain vanilla and easy to understand features, choosing the right plan could be arduous due to fast closure of schemes and multiple launches under same schemes or series. Also, one has to screen the reputation of the fund house and the fund manager along with choosing appropriate options such as growth or dividend based on one's needs; take all these into calculation when investing in an FMP.
Therefore, it is advisable to sound out your Investment advisor to identify the right product.
The most popular attraction of FMPs is their technical 'trick in the book' that saves you more in taxes. As one would agree, the most critical element in an FMP is the taxation aspect - if held for at least a year, one pays a long-term capital gains tax like all debt funds at the rate of 10.30% (including surcharge) without indexation or a higher tax of 20.60% with indexation (depending on your option). Thus, one ideally prefers indexation option in an FMP (tenure of 1 year plus, say 400-day FMP) that is launched closer towards the end of the financial year in March as it accounts for two fiscal years.
As per indexation rules, to account for the fluctuation in inflation and the resultant decline in value of money, one is allowed to inflate the cost price of a financial instrument which effectively narrows down the profit from investment. Thus, double indexation - where one enjoys benefits of two years by investing in FMPs for just over a year - can even bring down gains at times to negative, based on prevailing inflation, and provide taxation benefits on investments like FMPs.
Also, SEBI's strict supervision of FMPs (after investments in risky debt portfolios by some funds in the past) has ensured far higher safety for investments, this time around. However, despite the perception of safety, like all investments, FMP returns are not guaranteed (including the principal). As any investment advisor will tell you, you will be guided more by the performance of peer funds. Moreover, gains like double indexation may come to a halt under the Direct Tax Code and hence one needs to check with the advisor for future guidance.
To Amit's pertinent query, one can conclude that FMPs score over FDs in terms of tax benefits, especially for individuals in higher tax brackets who are taxed upwards of 30%. The trade-off for such benefits though comes in the form of slightly or possibly lower returns since FMPs do not give any indication of the range of returns possible while you get crystal clear clarity regarding FDs right from the word go. Also, all your possible calculations might end up below reality if markets are swayed by high volatility or your own fund manager underperforms peer schemes.
Experts say one needs to thoroughly understand the fine print about all key aspects of investments. FDs have a capital protection of up to INR1lakh whereas FMPs have no such security. In a volatile scenario, one should gauge the potential movement in interest rates before investing. Finally, unlike an FD, an FMP cannot be redeemed prior to maturity due to its locked nature, so count it out of your contingency plans.