FMP’s a better alternative to Fixed Deposits

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 three years or more. When the fixed period comes to an end, the scheme matures, and your money is paid back to you.

Some of the FMPs do invest a small portion of portfolio in equity which are called dual advantage fund. 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. In FMP 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 it is not permitted however you can sell it in the secondary market as all the closed ended scheme have to be listed in stock exchanges although finding a buyer for these securities is bit difficult. 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 fallen 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 compare to Bank FDs , FMPs currently offer a little higher rate of return; the tax impact tilts the scales in significant 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 capital gain is calculated after adjusting with Cost Inflation Index. The Distribution Tax rate @28.84% or the capital gains tax rate @20% are lower than the income tax rate, especially in the case of investors in the higher tax bracket where income tax on interest will be at 34.60% (30%+12% Surcharge and Education Cess). Tax directly eats into returns, which is why FMPs have the edge over Bank FDs.

Are FMPs for you?

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.

Let’s see how a longer termed FMP (of over one year) has an even better edge than a Fixed Deposit. The reason is that for an FMP of over one year, the return is taxed as long-term capital gain and not normal income. The following table summarizes the advantage that an FMP has over a fixed deposit.

In the case of an FMP, you have an option of paying tax on long-term capital gains @20% after indexing cost while for interest income you have to pay the tax as applicable to your tax bracket.

S. No.	Particulars	FMP of Mutual Funds	Fixed Deposit
A	Investment Amount	100,00,000	100,00,000
B	Post Expense Indicative Yield	7.50%	7.50%
C	Maturity Value after three years	124,22,969	124,22,969
D	Gain = C-A	24,22,969	24,22,969
E	Expected Annual CI Index	5.00%
F	Index Value for three years	1500000	0
G	Net Gain After Indexation (D-F)	9,22,969	24,22,969
H	Tax Payable @20%/ 30%	1,84,594	7,26,891
I	Total Income Cash Flow (D-H)	22,38,375	16,96,078
J	Maturity Value after three years	122,38,375	116,96,078
K	DIFFERENCE IN TOTAL CASH FLOW	5,42,297
	Additional return in % (K/A)	5.42%

As we can see from the table given above that the net return in FMPs can be as high as 5.4% compared to FDs when we expect the returns from both the instruments will be same although FMPs give little higher returns than FDs.

Are FMPs for Corporates/ Entities who are at higher tax bracket?

Well, FMPs are for everyone those who are looking a fix kind of returns. However the favorable tax structure makes it more attractive for those who comes under highest tax bracket. Corporates, Association of Persons and High Net worth Individuals. In fact, you can look upon FMPs as fixed deposits offered by mutual funds. Just like bank fixed deposits, Tax incidence differs as explained above.

As compared to other fixed income products like Bonds, Corporate Fixed Deposits FMPs fair better due to long term capital gain tax benefits as compared to interest which is fully taxable.

Also FMPs are quite safe since the underlying investments are either money market instruments or rated paper. Before investing, we can get an idea about the indicative yield from the scheme based on the current market scenario. 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 take a right advise through a professional Advisor.