x

Are FMPs the Norm of the Day?

Home »  Magazine »  Are FMPs the Norm of the Day?
Are FMPs the Norm of the Day?
Are FMPs the Norm of the Day?
Sandip Mukherji - 25 April 2019

Years ago I was sharing my concerns as a mutual fund distributor with a friend as to why clients did not understand mutual fund products? He made an interesting observation. About a hundred years ago Indian families did not trust the banking system and kept all their savings in cash or gold, about 6-7 decades ago our fathers trusted bank FDs, LIC and UTI and then about 20-30 years back they slowly started accepting mutual funds as a means of investment without realising that UTI schemes were mutual funds in their primitive form. There has been a quantum leap in the way our financial markets and acceptance of investment products have evolved over the last 100 years. Unfortunately, I find the knowledge of Fixed Maturity Plans (FMPs) as compared to Fixed Deposits (FDs) is still lacking in the investor fraternity. Here, I have tried to explain the concept and the benefits of FMPs over FDs.

 

What are FMPs?

Fixed Maturity Plans are funds that are locked-in for fixed duration at a fixed interest rate. The fund manager invests primarily into bonds or papers of debt of fixed maturities. FMPs could be of any duration and likewise the bonds and the papers will also have their maturities aligned to similar tenure. The FMPs are tax efficient but do not have an assured rate of interest and carry credit risk depending upon the construction of the schemes.

 

Why should we invest in FMPs?

FMPs have two distinct advantages over FDs, which are tax efficient, and secondly they have a higher return than that of FDs of similar duration. However they are locked-in and can only be redeemed on the exchanges of which the probability is low. They allow the investor to take certain amount of credit risk thereby increasing the gains for higher risk. Bank FDs are more liquid and the investor only loses 1 per cent of the assured interest rate of the period on premature withdrawal. In the current times due to the yields of the 10-year government securities being high, investment into the FMPs make a lot of sense.

Taxation in the FMPs is also much efficient since any FMP with a maturity of more than 3 years will be liable for indexation and long-term capital gains. On the other hand, the full income arising out of investment in FDs are added to the investor’s total income and taxed at the slab rate, which is applicable.

Indexation is the benefit that the investor gets due to annual inflation rate, which is deducted from the gross gains of an FMP (growth schemes) returns. The LTCG is 20 per cent minus indexation (applicable for number of financial years the investor is invested) for example I have made an investment on March 20, 2019 for three years one month, which will mature in April 19, 2022. I will get the benefit of four indexations on maturity of my FMP investment which will then be deducted from 20 per cent LTCG and the final figure will be much less than that of a FD taxation.

 

FMPs and credit risk

The investor can decide on the amount of credit risk he wants to take, to increase his effective rate of return. On one hand one can invest in the FMPs that have AAA rated bonds to increase their safety but lowering their returns. The credit risk increases as one goes down the credit rating ladder but the return increases. The highest credit rating would be AAA, which are Government bonds and then followed by AA onwards where the risk increases on every step downwards but so does the return. Hence the investor can pick-up an FMP where the risk- return ratio and the tenure can be customised as per his needs and risk appetite.

Remember, however the FMPs which are which are of shorter duration than three years will be subjected to short term capital gains taxation which are the same as the taxation in FDs. Hence the FMPs of tenures of less than three years will not be beneficial in terms of taxations over FDs.

The author is a wealth advisor and Founder, Tangerine Ideas

 

Dealing With Financial Imbroglio
Business Beating On All Fronts