Will these open MF FMPs give better returns than FDs? Here is the answer

Mutual funds not only invest in equities, but debt instruments also. Depending upon the proportion of investments in equity and debt, the funds are categorised into equity funds (where proportion of equity is 65-100 per cent) and debt funds (where proportion of debt is 65-100 per cent).

Fixed maturity plans or FMPs fall under the debt category, which are closed-ended schemes with a pre-defined maturity. Being a part of debt category, these funds invest in various debt instruments based on the investment objective and asset allocation of the plan such as debt instruments, certificates of deposit (CDs), commercial papers (CPs) etc, which have fixed tenure and fixed rate of return or fixed maturity value.

As the tenure and maturity values of the instruments constituting a fixed maturity plan are predetermined, like fixed deposits (FDs), the FMPs also provide fixed return and that are almost equivalent to the prevailing FD returns.

Now the question arises, if the returns on FDs and FMPs are almost the same, why should one invest in an FMP, which is “subject to market risks” and thus riskier than FDs?

It’s due to the difference in tax liabilities. While returns on FDs are treated as interest income, the returns of FMPs are treated as capital gains. However, the tax-efficient long-term capital gains (LTCG) will come into act only after the 3-year holding period in case of FMPs.

For the first three years, the returns will be taxed as per the marginal tax rate in which the investor falls. So, if an FMP and an FD offers the same return, the tax liability on investing in both the instruments will be the same in the first three years, making the FMP less attractive.

To avoid such a scenario, AMCs now issue FMPs with a duration of more than three years or more than 1095 days, so that investors get the benefits of LTCG.

Now let’s see how LTGC makes FMPs more attractive than FDs.

Let’s assume, an investor, who falls under the 30 per cent tax bracket, invested Rs 10 lakh each in an FMP and an FD on September 15, 2015 for three years and both the investments give 7 per cent annual return. Now let’s calculate, what will be the after-tax return on both the investments.

So, the total after tax return on FMP is almost 4.3 per cent higher than that of FD.