Continuing with our series this time we shall examine what the double indexation benefit means with regard to FMPs. Just as a snapshot, FMPs are akin to fixed deposits issued by mutual funds instead of banks. As mutual funds are not allowed to assure returns by SEBI, the yield is indicated and not assured. However, for all practical purposes, the indicated yield is what the investor gets at the time of maturity.

• Why FMPs are more lucrative than Bank FDs?

The basic advantage of FMPs is the tax efficiency as compared to Bank FDs. With comparable rate of interest (around 9% to 10% p.a.), the lower rate of tax on FMPs makes this product more attractive than the Bank FD. For short-term FMPs, investors should choose the dividend option as the rate of tax (dividend distribution tax) is 14.1625% whereas for longer termed FMPs (over one year), the growth option should be chosen since this way, upon maturity, the 10% capital gain tax will be applicable.

• Why FMPs are more lucrative than Bank FDs? - Part II

Now let’s turn to double indexation. Double indexation is a neat trick where you hold an investment for a little more than one year but get the benefit of the index multiple of two years. How is this done?

Investors would know that in the case of non-equity mutual funds (in this case FMPs), one has the option of choosing the lower of 10% tax on sale minus cost or 20% tax on sale minus indexed cost. More often than not, the 10% figure is lower than the 20% figure (in spite of indexation) and hence the tax is paid at the 10% rate.

However, under certain circumstances, a holding period of slightly more than one year can invite the facility of double indexation. In terms of an example, lets say you buy the FMP on 29th of March 2007. (I know the date has passed, however, it has been used in the example for a clearer understanding of the concept.)

Have a look at the following table.

The FMP is for 370 days, exactly 5 days more than one year. However, check out the date of investment and date of exit. The entry date is 29th of March, 2007 i..e FY 06-07. The date of sale is 2nd of April, 2008 i.e. FY 08-09.  By holding the investment for a little over 365 days, an investor can use the facility of indexation for two years. The rest of the table is self-explanatory. The double indexation usage boosts the cost due to which the investor earns a marginal capital gain. The net annualized return works out to 9.81% after-tax.

To Sum

Well, after all this analysis, at the end of the day, is the FMP product meant for you?

That would depend upon your take on the market. With stocks frothing over at the brim, perhaps you would like to stay out of the market and remain liquid. However, at the same time, you may not want to lock-in your funds for any length of time. Who knows, the much feared but anticipated correction may be around the corner --- at which time you will need ready liquidity. Or perhaps, you are a risk averse investor who would never play the stock market but nonetheless expect a reasonable return from your fixed income investment. Or perhaps, you have some money in hand that is required at a later stage but are looking to temporarily park it somewhere safe and gainful.

The point I am trying to make is no matter what the situation, a product like an FMP always comes in handy. Of course provided you know about it!

- Sandeep Shanbhag

The writer may be contacted at sandeep.shanbhag@moneycontrol.com

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