FMP’s – A great debt instrument for HNI’s
Fixed Maturity Plans or FMP’s have been quite popular for some time now. Many investors have parked lots of funds in them. Some consider it better than keeping money in a Fixed Deposit. However any instrument should be first understood & then only money should be parked in it. Only then does the investment make sense. We at Fpguru.com would like to enlighten you on FMP’s as well as provide a ground for comparison between FMP’s & the more well-known Fixed Deposits.
Fixed maturity plans:
FMP’s are close ended mutual fund schemes which invest mainly in debt funds. These have a fixed tenure, namely between 30 days and 5 years, and one cannot redeem the funds prior to the maturity. The most popular FMP’s being 30 days, 180 days, 370 days and 395 days. The main objective of an FMP is to provide the investor with a steady return over a fixed tenure, thus shielding them from interest rate fluctuations. Hence to achieve this, money is invested predominantly into debt instruments such as company deposits, commercial paper, Government- backed securities etc and usually lack an equity component.
How do FMP’s work:
The fund manager of an FMP invests the money into debt instruments which match the time period of your investment. Since FMP’s are close ended schemes, the money cannot be redeemed before the end of the tenure. This ensures that a fixed yield has been locked in. FMP’s being listed on the exchange and can be sold to another buyer, subject to availability of a buyer. Hence, you must invest into an FMP only when you do not need the money in the immediate future.
However, this does not make FMP’s completely secure. It will always face credit risk in case the borrower defaults in making the payment. To mitigate this risk, FMP’s ensure they invest into debt funds which are of investment grade. And owing to the comparatively higher risk, a high return also follows.
FMP’s vs FD’s:
FMP’s and FD’s are similar in several aspects such as, both are closed ended funds which primarily invest into debt funds. However, there are several pivotal differences such as:
FD’s promise a fixed rate of return till maturity, thus you are completely aware of exactly how much interest you would be receiving. However, in case of FMP’s, there is no fixed rate of return, but an expected rate of return. There is no guarantee provided to the investor, though the real return is near about the expected.
FD’s are managed by banks whereas FMP’s by Mutual Fund companies. Hence the success of an FMP greatly depends upon the fund manager.
FD’s have a fixed tenure but one can liquidate this money in the event of an immediate need by availing a lower rate of interest. However, in an FMP, you cannot redeem your money until maturity.
The most differential point between an FMP and an FD is taxation benefits.
A Fixed Deposit attracts tax at slab rate. So if you fall in 10% tax bracket, you pay that much tax & so on.
However, for an FMP, the tax rate is either 20% with indexation or 10% without. The most popular FMP’s to save tax is the one with tenure of 390 days. These if issued near the end of the financial year can have immense tax benefits. Consider the following. If you invest into a 390 day FMP in the month of March 2011 i.e: financial year. 2010–11 it will mature around May 2012 i.e. financial year 2012–13. This gives you a double indexation benefit thereby reducing your tax liability a great deal.
The tax benefits provided by an FMP definitely makes for a better investment instrument as compared to a bank FD, but only for people in the higher tax bracket especially in the 30% bracket. Even individuals in that bracket must take care to ensure that the FMP tenure matches one’s need and the funds are invested in debt instruments which are of high investment grade. And lastly always read the fine print before investing.
By Shalmali Kulkarni.
The writer is working as a para-planner with Fpguru.com
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