Are FMPs better than bank FDs?

Quite often investors think Fixed Maturity Plans and Fixed Deposits are alike but there are some distinct differences. Pankaj Mathpal of Optima Money Managers explains.

While fixed deposit offers higher liquidity, when you calculate post-tax return, FMP scores over fixed deposit. But the fundamental similarity between FMPs and bank fixed deposits is that both FMPs and Bank FDs are both close ended- both fixed maturity plans and FDs have a definite maturity date. “If you are in the higher tax bracket, definitely FMP scores over fixed deposit. You should have the FMPs in your portfolio, but otherwise, if you are looking for liquidity and you want more safety then this fixed deposit can be a better choice,” he advises. Below is the verbatim transcript of the interview Q: What’s the difference between Fixed Maturity Plans (FMP) and bank FDs? Which ones should you choose in what circumstances? A: FMP is a closed-ended debt oriented mutual fund scheme where the duration of the underlying asset is in line with the maturity of the scheme, which eliminates interest rate risk or reinvestment risk. If you compare this FMP with bank fixed deposit, bank fixed deposit offers you assured return and investment up to Rs 1 lakh in the bank is insured by Deposit and Credit Guarantee Corporation (DCGC). Secondly, bank fixed deposit has higher liquidity, but when you calculate post-tax return, here FMP scores over fixed deposit because fixed deposit interest is taxable as per slab rate applicable to individual. Depending on income, it maybe 10-20-30 per cent, but when you hold an FMP for more than one year, the capital gain is taxable at 10 per cent without benefit of index or 20 per cent with the benefit of index, whichever is lower. If you are in higher tax bracket, definitely FMP scores over fixed deposit. You should have the FMPs in your portfolio, but otherwise, if you are looking for liquidity and you want more safety then this fixed deposit can be a better choice. Q: But FMPs are usually above one year. What is their normal length? A: It maybe three months to 370-372 days. Different maturity schemes are available. It is not necessary that is more than one year. If you are looking to gain high yield, post-tax high returns, you should go for the FMP which are more than one year. Usually if it is more than 2-3 year, you will get the benefit of double indexation. _PAGEBREAK_ Q: What is the tax liability under one year? A: If you are holding less than one year, it is again calculated according to slab rate. If your tax liability is 10-20-30 per cent, the same will be applicable in the FMP also. Q: What is the kind of return one can expect in FMP if it is sub-one year or even more than one year? How does it compare with a bank FD? A: Basically these underlying assets are like bonds. So you can expect around 9-10 per cent returns. Return-wise, it will be hardly 0.5-1 per cent higher than the bank fixed deposit. But as I said, if you are paying 30 per cent tax on your fixed deposit and you are getting 10 per cent, what comes in your hand is 7 per cent. But if you are investing in FMP where you get 10 per cent and you pay only 10 per cent tax on that, so net yield is 9 percent. Therefore, if you are in the higher tax bracket, it make sense to invest in FMPs. Q: Where should I invest for child’s education requirements? A: You have a long term horizon of 10 years to 15 years. Since you want to generate extra return for generating higher returns, you will have to take little extra risk. But this risk can be minimized if you invest with good planning. You could have a balance portfolio of equity, debt and gold. If you do not want to invest in direct equity as you do not have much idea about equity investment, you can take help of mutual funds. Invest through SIP route regularly in equity or mutual fund scheme, you could invest 30-40% in equity. Some portfolio should be allocated in debt. You should have some bond funds in your portfolio and some gold saving funds. If your horizon is 10-15 years, you should invest in gold, equity and debt. When you are near to your goal, you should systematically switch from equity to debt. In equity, you can have a largecap fund like ICICI Prudential Focus Blue Chip. In debt, you can have UTI bond fund or SBI Dynamic bond fund, and in gold fund, you can have Reliance Gold Saving fund. Suppose you invest Rs 5,000 per month, you can invest Rs 2,000 in ICICI Prudential Focus Blue chip, Rs 2,000 in SBI Dynamic Bond Funds and Rs 1,000 per month in Reliance Gold Saving fund. In this way, if the investor wants to invest Rs 5,000, the investor can allocate it.