Why Fixed Maturity Plans are so popular among investors?
Fixed Maturity Plans have shown a huge interest among investors in the last financial year. With easy investing, tax benefits and good returns, FMPs continues to be the hot favorite among investors in spite of the recent rate cut by RBI. Read this space to know more about the product and the benefits it offer.
Fixed Maturity Plans or FMPs, as we know them, have shown a huge interest among investors in last financial year. All mutual funds companies put together have been able to collect Rs 1.75 lakh crore only in FMPs. Even the recent cut in interest rates by RBI does not seem to have any impact on the attraction of this product. The primary reason for such a high interest is the multifold benefits FMP offers to investors.
Let's understand how investors can reap the benefits by investing in Fixed Maturity Plans:
What are FMPs?
Fixed Maturity Plans are closed ended debt mutual funds scheme whose time horizon is fixed. The period ranges from 30 days to 3 years. From these, 1-2 years FMPs have been the favorites among investors. Being a debt scheme, the objective of an FMP is to give steady returns with capital preservation like FDs. The investment portfolio comprises of Debt securities such as certificate of deposit and commercial papers of nearly the same maturity as the scheme. So if duration is of 1 year it will invest in debt papers which mature just before one year. Since FMPs are closed ended scheme one can invest during the NFO period only. Once the NFO is closed investor can neither invest nor redeem it through Mutual Funds like open ended scheme. The only option to exit from any FMP is through stock exchange where they get listed as mandated by SEBI. However, liquidity is a major issue.
The returns from FMPs are not assured like FDs but with hold till maturity strategy one can expect fixed returns from this instruments at end of the specific tenure. The companies do not give any indicative returns now as market regulator SEBI banned it in 2009. As the product benefits more when prevailing interest rate scenario is high in economy, currently FMPs are able to offer 9.25-9.50% returns to investors for 1-2 year horizon.
Fixed Maturity Plans scores high on tax advantage when they are compared to similar instruments like fixed deposits. In FDs the interest earned is added to income and taxed at individual personal income tax rate which reduces the returns substantially for investors in higher tax slab. Contrary to this FMPs have different tax treatment as the nature of income is different but is highly efficient.
1. Dividend: Dividends in FMPs are tax free in hands of investors. However, mutual funds companies have to pay a dividend distribution tax of 12.5% (plus surcharge & cess) before distributing it to investors. Thus, any investor who opt for this option pays tax of this amount on earnings, although indirectly. This is far lower when compared to FDs where interest earned is taxed at individual personal income tax rate.
2. Capital Gains: If any investor opts for growth option, he is subject to capital gains tax. Short term gains are taxed as per the tax slab while long term gains are taxed at 10% without indexation or 20% with indexation. The indexation benefit inflates the cost of purchase lowering long term gains tax liability. This fare far better than FDs where no such benefit is available.
3. Double Indexation: This is the catch in the product. By investing during the end of financial year (March) in FMPs with over a year tenure, investors are able to avail double indexation benefit as it covers two accounting period. However, there has been ambiguity over DTC doing away with this benefit.
Here is a small comparison which shows the net yield to investors and how FMP score over FD
The investment option has some inherent risk which should be well known to investors. The primary of these is the Credit Risk which companies reduce by investing in highly rated instruments but investors should do their own analysis. The returns from FMPs also vary w.r.t. interest rates. When interest rates falls, yield from FMPs falls too. Also, unlike FDs, the returns from FMPs are not pre-known and the product has low liquidity.
Benefit of investing in FMPs score high when compared to similar instruments. However, one should analyze well the track record of fund house and previous FMPs portfolios before investing to minimize any risk which can impact your investment objective.
The author is a Certified Financial Planner and founder of JS Financial Advisors. You can reach him at firstname.lastname@example.org