Why FMPs are more lucrative than Bank FDs?

What is an FMP?
FMP stands for Fixed Maturity Plan. These are essentially close-ended income schemes with a fixed maturity date i.e. that run for a fixed period of time. This period could range from one month to as long as two years or more. When the fixed period comes to an end, the scheme matures, and your money is paid back to you.

FMPs do not invest in equity. The portfolio is generally invested in debt and money market instruments maturing in line with the tenure of the scheme. The objective is to lock-in the investment at a specified rate of return thereby immunizing the scheme against market fluctuations.

Liquidity
In most open-ended mutual fund schemes, one can redeem one's units anytime. However, the structure of the FMP does not lend itself to this kind of liquidity. Invest money you are more or less sure you are not going to need during the tenure of the plan. If you withdraw before the scheme closes, generally a steep exit load is imposed.

The reason for this steep load is to deter investors treating the FMP like a normal income scheme. Though income schemes invest in similar instruments as an FMP, being open-ended and not having a specific tenure based investment strategy, these are subject to interest rate risk leading to fluctuations in the NAV.

What is better --- A Bank Deposit or a FMP?
Lately the interest rates on bank deposits have increased leading many investors to wonder whether a simple Bank Fixed Deposit (FD) would serve better than having to go through the process of investing in an FMP. Though Bank FDs and FMPs currently offer a similar rate of return; the tax impact tilts the scales in favour of the FMP.

Interest on Bank FDs is fully taxable whereas the return from FMPs is either subject to the Dividend Distribution Tax (for the dividend option) or the capital gains tax rate (for the growth option). The Distribution Tax rate @14.16% or the capital gains tax rate @10% are lower than the income tax rate, especially in the case of investors in the higher tax bracket. Tax directly eats into returns, which is why FMPs have the edge over Bank FDs.

 

 

 Are FMPs for you?
As I write this, markets are extremely choppy. Depending upon whom you talk to, either a severe correction is round the corner or the market is going to go up by a couple of thousand points more. Though no one has seen what tomorrow will bring, common sense indicates that a post tax yield of almost 9% is too good to ignore.

If you are looking for a fixed income avenue that yields a reasonable return with minimum risk, adequate liquidity and tax efficiency, FMPs will provide you with an effective shelter.

This article was about how short-term FMPs (of duration less than one year) can benefit investors. Next time, we shall examine how longer term FMPs (of over one year) which yield capital gains benefits instead of dividend income can also be used for investments that have a longer time horizon.

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.