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

Published on Fri, May 18, 2007 at 18:15 | Source : Moneycontrol.com

Updated at Wed, Jul 18, 2007 at 13:21

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Last time (Read - Why FMPs are more lucrative than Bank FDs?) we discussed how a Fixed Maturity Plan (FMP) while yielding almost the same return as a bank fixed deposit, is superior to the latter on a post-tax basis. The example taken was of a 91 day FMP. This time we shall see how a longer termed FMP (of over one year) has an even better edge than its shorter-termed counterpart. The reason is that for an FMP of over one year, the return is taxed as long-term capital gain and not normal income. Readers of these columns would know that the capital gains tax structure is much more beneficial than normal income tax.

The following table summarizes the advantage that an FMP has over a fixed deposit.

	LONG-TERM FMP OF 366 DAYS
		FMP- TAX @20% WITH INDEXATION	FMP- TAX @10% WITHOUT INDEXATION	Fixed Deposit
		FMP- TAX @20% WITH INDEXATION	FMP- TAX @10% WITHOUT INDEXATION	Fixed Deposit
		Rs.	Rs.	Rs.
A	Investment Amount	100,000	100,000	100,000
B	Post Expense Indicative Yield	10.25%	10.25%	10.25%
C	Maturity Value	110,250	110,250	110,250
D	Gain = C-A	10,250	10,250	10,250
E	Inflation Rate For Indexation	5%	N.A
F	Cost after inflation	105,000	N.A
G	Capital Gain = C-F & C-A	5,250	10,250
H	Tax Rate	20.00%	10.00%	33.99%
I	Tax	1,050	1,025	3,484
J	Post Tax Gains = C-I	9,200	9,225	6,766
K	Post Tax Annualised Returns =	9.20%	9.23%	6.94%

In the case of an FMP, you have an option of paying tax on long-term capital gains either @20% after indexing cost or @10% on the profit (sale value - cost without indexation). While the option to adopt would depend upon parameters such as the duration of the investment, the return, the inflation rate etc., you would observe that both options are far superior to the fixed deposit investment.

Are FMPs for you?
Well, FMPs are for everyone. In fact, you can look upon FMPs as fixed deposits offered by mutual funds. Just like bank fixed deposits, FMPs too are of differing periods such as 30 days, 90 days, 180 days, 366 days and so on. Tax incidence differs as explained in these articles.

Also FMPs are extremely safe since the underlying investments are either money market instruments or rated paper. They have nothing to do with the Sensex movement and everything to do with interest rate movements. Before investing, the MF indicates the yield that you can expect from the scheme. The word used is "indicates" as against "assures" as SEBI rules do not allow mutual funds to assure returns. In any case, just like in the case of a bank fixed deposit, in an FMP too, investors would know beforehand what the return is going to be. And lastly, to choose an FMP, you should do just what you would do while choosing a fixed deposit......invest with a fund house with pedigree and reputation.

Next time, we shall examine yet another benefit that an FMP offers under certain situations called double indexation.