Traditionally almost around 85% of the people in India invest their surplus funds in Bank Fixed Deposits, Postal Schemes etc. This clearly indicates that safety and security of the principal amount is the first priority when it comes to investment.
Traditionally almost around 85% of the people in India invest their surplus funds in Bank Fixed Deposits, Postal Schemes etc. This clearly indicates that safety and security of the principal amount is the first priority when it comes to investment. Nobody cares whether the accretion on such investment is taxable or not. Also people do not evaluate whether the post tax returns will be able to beat inflation or not. Nobody can certainly deny the importance of safety but one has to always search for and evaluate the options which are equally safe but can give help you generate better returns or can give tax advantage over other equally safe investment avenues. It is important to have debt in your investment portfolio but it should be limited to certain percentage of total assets depending on time horizon and your risk profile.
Thumb rule says debt must constitute minimum equal to one’s age in percentage terms but it is advisable to allocate funds in debt depending on time horizon of your particular financial goal. If time horizon for a particular goal is just 1 year to 1.5 years than 100% of such corpus in debt makes sense. Most of the investors invest their funds in bank fixed deposit for time horizon of 1 to 1.5 years. But there are other alternatives available in the market which can give you better post tax returns compared to bank FDs and are equally safe. Mutual Funds FMP (Fixed Maturity Plans) are the better alternative for time horizon of around one year investments compared to bank fixed deposits which not only gives higher return but are also tax efficient. FMPs are closed ended schemes with the maturity period ranging from 370 days to 390 days which are commonly known as 1 year FMP. The maturity period of FMPs may vary from 90 days to three years but most prevalent and tax FMPs are one year FMPs.
Here we will discuss the pros and cons of only 1 year FMPs. These schemes invest 100% of their corpus in debt portfolio which consists of corporate and government bonds or Certificate of deposits issued by banks which are safe and rated. The funds thus invested are relatively safe compared to income funds as the volatility in the interest rates will not affect returns of the fund as the entire corpus collected in the scheme is invested for the fixed term which is almost equal to the tenure of the fund. These funds are closed ended in which investment can be made only during the NFO period. The schemes get listed at recognised stock exchanges but effectively these are not traded and volumes are negligible so one has to hold this till maturity for all practical purposes. Thus they are almost at par with bank FDs as far as tenure of investment and risk is concerned. The only difference is that in case of bank fixed deposit you know what return you will get at the time of making the deposit itself. Whereas in case of FMP the returns are not guaranteed it is market linked and returns will depend on the return of the portfolio. However one can find out as to what will be the indicative investment return from a particular FMP. The returns on this are higher than bank fixed deposit because they are floated for identified borrowers and as the volume size is big, they can easily negotiate for better deal. Moreover income arising out from this will be taxable under the head long term capital gain as the same is held for more than one year and investors get benefit of indexation. Please note that the benefit of indexation and concessional tax is not available in case of bank FD.
Since the FMP looks better than bank FD and if one wants to invest in FMP what one should look for while investing in FMP?
The one most important thing an investor needs to check before investing is the ratings of the portfolio in which the fund is likely to be invested. The investors should invest only in the schemes which will invest their funds in AA+ and above rated papers or bonds. The funds which invest in AA- papers or bonds or lower rated are more risky and one should be aware of risk involved in such schemes. For past one year of 1 year FMP is around 10% and above as compared to bank fixed deposit rate of 8.50%. Needless to say an FMP not gives higher return compared to fixed deposits but also has added tax advantage.
The writer is CFPcm , Head- Financial Planning