Fixed Maturity Plans (FMPs) is an avenue that should be considered before making an investment decision. FMP is equivalent to a Bank FD in a mutual fund but unlike FDs it cannot offer a fixed return.
Whenever, we think of fixed returns, the first investment avenue that comes to our mind is bank fixed deposit (FD). We often tend to follow the traditional investment avenues as these are considered safe and provide fixed returns. But Fixed Maturity Plans (FMPs) is another avenue which should be considered before we make an investment decision. Let us explore what FMPs are and how do they score over a bank FD.
What are FMPs
FMP is equivalent to a Bank FD in a mutual fund but unlike FDs it cannot offer a fixed return. However, by nature the returns on the FMP are locked as all the investments are held to maturity. As the name denotes, the maturity of securities in portfolio equates with maturity of the FMP. They fall under the closed ended debt category of mutual funds which has exposure only to fixed income securities for different maturity periods. The primary objective of a FMP is to generate income and protect fluctuation in the capital due to interest rate variations. They are also known as fixed tenure funds and fixed horizon funds.
FMPs have exposure to high quality bonds (generally AAA/AA rated). As FMP being a debt fund, the portfolio is more tilted towards fixed income securities like certificate of deposits (CDs), commercial papers (CPs), Corporate Debt, floating rate instruments, pass through certificates (PTC), money market securities, government securities etc. The exposure across different debt instruments makes it more attractive and reduces the portfolio risk.
The FMP comes with different maturities like 1 month, 3 months, 6 months, 1 year till 3 years. The different maturities provide an option to investor to choose an FMP as per their investment horizon.
Also one important point to note here is that unlike other debt funds, the fund managers do not need to undertake the review of portfolio because the instrument in portfolio matures with the tenure of the scheme. Thus, the expense gets reduced to a great extent.
How FMPs score over FDs
The biggest differentiator between a Bank FD and an FMP is the Income Tax Arbitrage opportunity available. FMPs (if you have opted for Growth option) is taxed as capital gains and if you have opted for dividend option, it attracts Dividend Distribution Tax (DDT). Please refer to our earlier article on Taxation on Debt Funds. The below illustration explains how one can optimize their tax liability:
Investment of Rs.1,00,000 in FMPs & Bank FDs for period of 1 year
*Cost Inflation Index (CII) for 2011-12 -785 and for 2012-13 -852, it is assumed cost inflation will rise by 9% as in the past.
Capital gains tax is 10% or 20% with indexation whichever is less
On pre tax basis one is not able to make out which investment avenue is better, but as seen in the above example the impact after reducing taxes is indeed very significant. An investor can get 42% more return than a FD.
The FMPs are best suited for investors (specifically in the tax bracket above 20%) who are looking for a risk free investment avenues.
Options to choose from are as under:
To conclude although bank FDs offer guaranteed returns and FMPs cannot, there is merit to invest in FMPs vis-a-vis FDs due to higher tax efficient returns offered by FMPs. However, there is one limitation with regard to liquidity. Even though these are listed on the Stock Exchange, there is no liquidity and typically the investor has to hold the investment till maturity. Presently, investors could look at FMP as a suitable investment option in the current environment.
READ MORE ON fixed deposit, Fixed Maturity Plans, mutual fund, high quality bonds, certificate of deposits, commercial papers, Dividend Distribution Tax
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