Given the current turbulence in the market, debt seems to have caught the investors? eye recently. And within debt, fixed maturity plans (FMPs) seems to be the flavour of the season. Let us take a closer look at FMPs and see how they fare against the more popular fixed deposits (FDs).
FMPs are closed-end debt funds that aim at generating returns that are indicated at the time of launching the scheme. Mutual funds are not allowed to provide assured return schemes. FMPs, therefore, only indicate the likely returns. Hence, these two avenues are comparable on the grounds that both have stipulated lock-in periods. FMPs also invest in bank deposits, thus making them look a bit too alike each other. However, FMP is a little better than FDs in some respects.
The key behind choosing FMPs over FDs is the tax efficiency; however, they work starkly different for short-term and long-term investments.
Fixed deposit returns are treated as other income and taxed at normal rates, which could be as high as 33.99%, irrespective of the term for which the money is deposited.
FMPs in the short-term score better with dividend distribution tax (DDT) applicable at 14.16% (benefit of 19.83%) and, in the long term, they have the benefit of ?indexation?, which gives the option of paying taxes ?20% with indexation benefit and 10% without indexation benefit (lower of the two).
Normally, in March, a slew of FMPs are launched (with 12-month lock-in periods), with the fairly obvious objective of providing the investor with the double indexation benefit. Double indexation, in some cases, can even lead to a net loss figure, even though there is actual profit on investment and, thus, expunge the tax obligation of the investors.
Take an example of a 13-month FMP, which, if launched on February 2010, will mature in March 2011. It will pass through two financial years and, thus, have the benefit of double-cost indexation. The underlying instruments of FMPs are bank deposits; however, they work out to be more tax efficient than direct investments in bank FDs.
Given that the interest rates are close to peaks, it is a great avenue to lock-in at prevailing rates. Note that given the lock-in, liquidity is limited in this avenue. It is suggested that you set aside a small percentage of your portfolio towards FMPs within your debt mix and the time is right now.
n The writer is chief executive officer of Right Horizons