What are fixed maturity plans? How do they compare with fixed deposits?
FMPs or fixed maturity plans are closed-end debt funds. They have a stipulated maturity period, say for three or seven years. FMPs are open for subscription only during a specified period at the time of launch - that is why they are called closed-end funds. They are listed on bourses and invest in money market instruments such as government securities, corporate bonds, commercial paper, certificates of deposits and treasury bills. Thus, the returns on FMPs are not fixed, but only indicative.
On the other hand, FDs allow an investor to park his or her money with a bank or financial institution until a specified maturity date. Since the interest rate is decided at the time of opening of the FD account, the investor already knows the maturity value of the amount at the time of investment.
Features of FMPs vs FDs
FDs might assure you of fixed returns and hence offer more security but experts believe that FMPs offer a higher interest rate than FDs.
"In absolute terms, fixed deposits today give a return of around 6.5 per cent to 7.5 per cent and in fixed maturity plans, it is from 8 per cent to 8.5 per cent. So if we consider before tax basis, there is a slight additional return of 0.5 per cent to 1 per cent in fixed maturity plans," Pankaj Ladha, a Rajasthan-based investment guru, told NDTV.
(Also Read: Latest Bank FD Interest Rates: SBI, ICICI Bank, HDFC Bank, Canara Bank)
"FMPs offer a higher yield than FDs. Bank FDs invest only in debt securities and give lower returns compared to FMPs," CS Sudheer, CEO and Founder, IndianMoney.com, which provides financial advice to investors. If your financial goal is to buy a car three years from now, invest in an FMP with a maturity of three years, he added.
Taxation policy on FMPs, FDs:
FMPs offer indexation benefit, which means that one can get higher returns via FMPs after paying tax. The gains/returns you get from FMPs are called capital gains. Indexation lowers capital gains, which translates into lower taxes, said Mr Sudheer.
(Also Read: Post Office Recurring Deposits (RD) Compared With SBI Recurring Deposit Accounts)
In FDs, the interest income is added to the investor's income and is taxable at the applicable tax slab, also known as marginal rate of tax. In FMPs, a time horizon of above three years provides indexation benefit and a flat tax of 20 per cent post-indexation, said Mr Ladha. "In a nut shell, post-tax returns of FDs, considering a 30 per cent tax slab of investors is around 4.30 per cent to 5 per cent vs post tax returns of FMPs - considering a 30 per cent tax slab of investors - comes around 7.25 per cent to 7.50 per cent. That means post tax effective higher returns of around 3 per cent on (FMPs). However, the tax indexation benefit is available for FMPs of over three years only," he added.
If you sell your investments in FMPs after three years, gains are called long-term capital gains (LTCG). LTCG is taxed at 20 per cent with the indexation benefit. Indexation allows you to inflate the purchase price, said Mr Sudheer. LTCG is basically the tax paid on profit generated by an asset such as shares or share-oriented products held for a particular time-span.
(Also Read: Seven Income Tax Rules That Will Come Into Effect From April 1)
Liquidity on FMPs, FDs:
Suppose you need money urgently. Obviously, you would want to fall back on your investments. FDs here come in handy because FDs offer a premature withdrawal facility. FMPs are generally meant for investors who do not mind keeping their money locked-in for at least a period of three years.
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"There are liquidity restrictions in both the cases but fixed deposits are relatively more liquid in comparison to FMPs. In the case of FMPs investors need to stay invested for at least for three years to take the benefit of indexation on long-term capital gains tax. However, FDs can be withdrawn before maturity with nominal penalty or in some cases with no penalty, making it more liquid than FMPs," said Pradeepta Sethi, associate professor, finance & strategy, T A Pai Management Institute (TAPMI), a management institution.
Risks on FMPs, FDs:
Since returns on FDs are fixed, they generally make an investor feel more secure than FMPs.
"FMPs are exposed to the risk of one or more of their underlying papers defaulting (credit risk), and this could potentially hamper their returns. They are also exposed to a risk known as 'reinvestment risk' - that is, the risk that the fund manager will need to reinvest maturity proceeds at a lower than earlier rate," said Amar Pandit, CFA, founder and 'chief happyness officer' at HappynessFactory.in, a financial advisory firm.
However, most people are not aware of it but even FDs are also insured only up to a sum of Rs 1 lakh. "Thus, an FD investor needs to be aware of the existence of such risks," said Mr Pandit.
(Also Read: SBI Raises Fixed Deposit Interest Rates. Details Here)
So which is a better option: FMPs or FDS?
"In the current market scenario, the yield curve is elevated, including the short end of the yield curve, making FMPs a potent option to lock in surplus funds available. This could well be a strategy going into FY19," said Lakshmi Iyer, CIO-debt & head-products, Kotak AMC.
"Fixed maturity plans perfectly cater to individuals as well as corporate houses. They have the twin advantage of higher returns plus tax efficiency," said Mr Ladha.
"The coupon rates of bonds have moved up but FD rates have remained low. In such a scenario, locking into high quality (AAA-rated) portfolio of FMPs can deliver superior returns to FDs," said Ms Bala.
However, Mr Pandit is more cautious on choosing between FDs and FMPs. "FMPs are the mutual fund industry's version of fixed deposits...As an investor, you need to think carefully about which one suits you the best. As with all investments, consider your unique situation and preferences before you invest," he said.
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