Fixed maturity plans offer better post-tax returns than bank FDs, expecially for those in the highest tax bracket
For risk-averse investors, fixed maturity plans (FMPs) of mutual funds are a good alternative to fixed deposits. These closed-ended debt funds invest in debt instruments with less than or equal to the maturity date of the scheme. The maturity period can range from one month to five years.
The investment objective of FMPs is to generate returns and protect the capital invested as the schemes invest in debt products with a fixed maturity. FMPs ensure low risk of capital loss as compared to equity funds because the funds are invested in debt instruments and the securities are held till maturity. They also offer better post-tax returns than bank fixed deposits, especially for those in the highest (30%) tax bracket. These funds offer indexation benefits, which helps to lower capital gains and thus lower the tax outgo.
Less volatile than equities
In most cases, FMPs invest in certificates of deposits, money market instruments, commercial papers and highly rated securities (like ‘AAA’ rated corporate bonds). Based on the tenure of the FMP, fund managers invest in debt instruments in such a way that all of them mature around the same time and there is no pressure at the time maturity.
So, returns from them depend on the prevailing rates in the money market and investors get an indicative rate of return of the plan. Also, these instruments are held till maturity, which saves on churning costs and results in a lower expense ratio for investors.
Negligible interest rate risk
Being a debt product, FMPs have negligible interest rate risk as the schemes invest broadly in assets maturing on or before the scheme maturity. Over time, debt as an asset class works well and builds up a strong portfolio. As per the norms of the markets regulator, a mutual fund cannot provide an assured returns scheme. So, FMPs only indicate the likely returns that the scheme will give to investors.
Liquidity is an issue
If an investor is looking at liquidity, then he should prefer bank fixed deposits. In case of any emergency, bank fixed deposits can be liquidated, with some penalty for premature withdrawal. But in FMPs one just cannot liquidate the money as the funds are close-ended and it can be withdrawn only after the scheme matures. FMPs can only be traded on the stock exchange where they are listed. As the secondary market is not yet developed in India, trading becomes very difficult.
Bank deposits also score better than FMPs on protection of principal amount. Under Deposit Insurance and Credit Guarantee Corporation (DICGC), each depositor in a bank fixed deposit is insured up to a maximum of R1 lakh for both principal and interest amount as on the date of liquidation of the bank’s licence. All commercial banks, branches of foreign banks in India, local area banks and regional rural banks, are insured by the DICGC. All state, central and primary cooperative banks, also called urban cooperative banks, are covered under this. However, in FMPs there is no such guarantee on the capital in case the fund house suffers a loss on the investments made or if the debt paper turns junk.
If an individual is in the 10-20% tax bracket, then bank fixed deposits or corporate fixed deposits with AAA rating could be considered. However, if an investor has no need to liquidate the investments and is in the 30% tax bracket, then a three-year FMP would make sense.