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Fixed Maturity Plans - FMPs

The buzz word in the mutual fund industry is Fixed Maturity Plans.What are they? Fixed Maturity Plans (FMPs) can be termed as the mutual fund industry’s answer to Fixed Deposits (FDs). Over the years, FMPs have established themselves as an option for debt fund investors (i.e. risk-averse investors). In many cases, they occupy the slot that used to belong to FDs. This is not surprising given that both the avenues cater to the same investor category. Having said that, it is worth noting that FMPs and FDs also vary across a few critical parameters. It is important that investors appreciate the dissimilarities between the two avenues so as to make the right investment decision.

Which is the better option? FMPs or Bank FDs? This note highlights the difference between FMPs and FDs, and guides investors on selecting the option most suitable to them.

Assured returns vs Indicative returns
The defining feature of both FMPs and FDs is that investors know in advance how much return they will earn on maturity. The difference is, while the returns on FDs are assured, returns on FMPs are indicative. However, many investors confuse FMPs with FDs and believe that the returns offered by FMPs are also assured.

FMPs are actually close-ended debt funds (investments can be made only during the new fund offer period) with a fixed maturity offering an indicative yield (both the maturity and yield is known upfront). Here the keyword is indicative. That means, on maturity, there is a possibility of the actual returns deviating from what has been indicated to investors at the time of investing. On the other hand, returns are guaranteed in an FD and investors are assured of receiving the same on maturity.

FMPs: Don’t ignore the risk

Varying tax treatment
The tax treatment on interest income is different for FMPs and FDs. In FDs, the interest income is added to the investor’s income and is taxable at the applicable tax slab (or the marginal rate of tax).

As far as FMPs are concerned, the tax implication depends upon the investment option – dividend or growth. In the dividend option, investors have to bear the Dividend Distribution Tax. Whereas in the growth option, returns earned are treated as capital gains (short-term or long-term depending on the investment tenure). In the case of short-term capital gains (i.e. if investments are held for less than 365 days), the interest income is added to the investor’s income and is taxed at the marginal rate of tax.

In a nutshell
While FMPs offer superior post-tax returns vis-à-vis FDs, returns offered by them are only indicative and not assured. Given the fact that returns are not assured, FMPs are riskier than FDs.

Having said that, it should be noted that FDs also have their own share of risks. FDs are usually rated; the credit rating of an FD is an indicator of the degree of risk associated with it. For instance, a rating of ‘AAA/FAAA’ offers the highest level of safety. So, an FD with a credit rating lower than this (as also an unrated FD) carries higher risk.

What should investors do?

For investors, looking for a competitive return at minimum risk, both FMPs and FDs are options. To choose between them, investors need to take into account their risk profile and investment objective among other factors. For instance, while FMPs may appeal to investors willing to take a little risk for that extra return.

FDs will find favor with investors who are satisfied with a lower but assured return.

Comments

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