Expert advice

Jul 11, 2011,12.18 IST

Wary of equities? Check the new age mantra of FMPs

By Suresh Sadagopan, Principal Financial Planner, Ladder7 Financial Advisories

Hemant is down in spirit as his substantial stock investments have come down in value. He is cursing himself for investing so much in stocks, much against his native intelligence. He now wants to invest money in Fixed income instruments like FDs, NCDs, Bonds etc. His friend Manish counsels him not to panic about the equity investments, and suggests that he even increase the holdings in equities as the equities as percentage of his assets would have gone down. Hemant was looking at Manish, as if he were a gibbering baboon.

Manish understood and changed tack. Most investors including Manish, are wary of investing at this point, given the volatility. At an intuitive level, Manish understands that it would be a good idea to invest in equity now. But, he just does not have the will to follow that through. Hemant wanted something safe.

Manish was now explaining to Hemant about Fixed Maturity Plan (FMPs). Debt instruments were offering good returns. But when he heard that the post-tax returns in a FMP can be as high as 8.5- 9%, he was salivating. Bank FDs, were offering upto 10.5% per annum interest. That looks impressive. But, for a person in the highest tax bracket, it translates to a post-tax return of just 7.25%.  The difference between the returns offered by FMPs is between 17-24% more than FDs, on a post-tax basis.

Hemant was all ears… he wanted to know all about FMPs. Manish started to explain.  FMPs are essentially debt Mutual Fund schemes with a tenure, which invest in a basket of securities like Certificate of Deposit (CD), Commercial Paper (CP), Structured Obligation, Bonds etc. There is no equity exposure in these. The tenures can typically range from 90 days to 3 years, though the most popular ones are those of one year plus duration.  There is a reason to this. Hint – taxation.

The tax treatment in a debt Mutual Fund of which FMP is a part, is benign. It is subject to capital gains tax of the lesser of 10% without indexation and 20% with indexation.  Assuming that the FMP gives a gross yield of 10.5%, the yield after tax comes to 9.45% & 9.8% respectively. The charges typically are about 0.2% - 0.4% in FMPs. Hence, the net return after charges in this example, would still be above 9%. One year CDs are yielding over 10% now, making FMPs an attractive proposition. Hemant was warming up to this subject.

Hemant wanted to know about the taxation treatment in case of investments of less than a year duration. For debt funds of less than one year duration, Capital gains are taxed at the applicable income-tax slab rate. That makes those FMPs below one year duration on par with a bank FD. However, if one goes for a dividend distribution option, the net return is still much higher than in an FD. Manish continued his illuminating exposition.

If one were in the Dividend distribution option, the Dividend distribution tax (DDT) is applicable. That tax is to be paid by the Mutual fund. The Mutual fund pays that tax and distributes the balance amount to the investor, which is tax free in the hands of the investor. The DDT is 13.519%. Hence, if a scheme is offering 10% returns, the post-tax returns in the hands of the investor is still a very healthy 8.65% annualized return. This makes FMPs a very good option for investors.

Manish concluded… for FMPs of less than one year duration, one should opt for the Dividend option & for those with over one year duration, Growth option is the best choice, especially if one is in the 20-30% tax bracket.  Hemant was by now sold on FMPs.

Video Tutorials

Harsh Roongta

Planning to invest in mutual funds? Here's help

Pankaj Mathpal

Here are a few fund options to invest your money

more

Take a mf iq test

New to Mutual Funds?

Take a test and get a Badge

Take a Test

New to Mutual Funds?

Take a test and get a Badge

Take a Test

New to Mutual Funds?

Take a test and get a Badge

Take a Test