Who can invest in Fixed Maturity Plans (FMPs)? What type of investors can consider investing in FMPs?
We are all very fond of fixed deposits (FDs). We often use FDs more as a mean of locking our money than as an investment. Why?
Because the return of fixed deposits have gone down considerably over a period of time.
So Fixed Deposit fans, what you can do?
You can consider an alternative investment vehicle. It is Fixed maturity Plans (FMPs).
Like FDs they can also generate fixed returns, and has a lock-in period.
Fixed Maturity Plans can also be used by people to save income tax.
Though FMPs are not exactly tax saving options, but as they come with indexation benefits, ones tax liability compared to FDs.
#1. What are Fixed Maturity Plans (FMPs)?
Fixed maturity plans are nothing but “closed-ended” mutual funds which are mainly “debt based”.
Close-ended means, it has a lock-in period (1 month, 1/2/3 years etc).
What means by debt based funds?
A debt based fund do not invest in equity. They invest in options like:
- Commercial Papers
- Certificate of Deposits
- Treasury Bills
Typical portfolio composition of a Fixed Maturity Plans is shown below:
What makes FMPs suitable for risk averse investors (who like FDs), is the quality of instruments they include in their portfolio.
You can see from the above image, the portfolio of a typical FMP includes debentures, bonds etc of Credit Rating A, A+, AAA etc.
Investment objective of a typical FMP mutual fund is as below:
#2. Which is better FMPs or FDs?
Lets take an example of Axis Bank’s fixed deposit interest rates.
If one would invest in a fixed deposit with following lock-in periods, the interest offered by the bank are:
- 3 Years – 6.9% per annum.
- 1 year – 6.75% per annum.
But if we see the historical return on Fixed Maturity Plans, the results are as below:
#2.1 Three Years Returns
Total 374 nos FMP mutual funds considered for evaluation.
Average return of these 374 nos funds in last 3 yeas was 7.97%.
#2.2 One Year Return
Total 990 nos FMP mutual funds considered for evaluation.
Average return of these 990 nos funds in last 1 year was 6.87%.
In a scenario, where interest rates offered by fixed deposits are inherently higher, FD returns may match the returns of FMPs.
What are those scenarios? When inflation rate is high in the country like in year 2012-13.
But when interest rates on FD is falling (like from Apr’16 to Dec’17), FMPs are sure to be the winners.
In fact, it is quite easy to choose between FD’s and FMPs, right?
#3. Benefits of investing in FMPs?
FMPs come with indexation benefits. While in FD’s indexation benefit is not available.
What indexation does is to enable the investor to pay tax only on the “net effective gain”.
What is net effective gain?
Return of the fund adjusted for inflation is the “net effective gain”.
To know more about indexation and how it is calculated read this blog post.
In FMPs, there are two options available:
- Dividend option.
- Growth option.
In dividend option the investor has to face Dividend Distribution tax, plus the applicable tax as per ones tax slab.
In growth option, there are two cases:
- STCG (Short term capital gain) – sell off before 3 years of holding time.
- LTCG (Long term capital gain) – selling after 3 years.
In STCG, tax is applicable as per ones tax slab. There is no indexation benefit available here.
In LTCG, tax is applicable @20% flat. But one can use the indexation benefit.
Another benefit of FMP is related to its expense ratio.
When people buy FMP, they do it with the objective of holding it till maturity. There is no short-selling observed in FMP.
This is why frequent trading in FMP is uncommon.
As a result, no major administration of FMP funds are required (compared to equity based funds).
Hence, expense ratio of FMP mutual funds range between 1% to 2%.
#4. Limitations of Fixed Maturity Plans (FMPs)
Till now we have seen only why to invest in Fixed Maturity Plans (FMPs).
But it is also important to know its limitation’s.
Though I must accept that, if comparison is with FD, there are not many limitations of FMPs.
I have listed here some for your quick reference:
#4.1 Non assured return
Banks stands as a guarantees when you buy its fixed deposit. Hence the return of FD is almost assured.
But the return of FMPs are not as assured as that of fixed deposits.
The surety of return will come when we see a FMPs portfolio composition.
More A, A+, AA, AAA credit rating securities are included, higher will be the reliability.
#4.2 Premature exit is not easy
Both FD and FMPs have a fixed lock-in period.
But in FDs, people can absorb a small penalty and liquidate the FD prematurely.
But in FMP, early exit is not allowed.
This is one reason why, experts advice people to invest in FMPs only when one is sure that they are not going to need the funds before the maturity date.
#5. How to Buy a Fixed Maturity Plan?
One can use a website like fundsindia to purchase FMPs.
Log into the fudnsindia account.
Once you are logged in, check the vertical menu bar on left of the screen.
Go to Mutual Funds > New Investment > In the new window click “Add Scheme”.
Once the “Add Scheme” button is pressed a new window will open.
In the new window one needs to click the tab called “NFOs/FMPs”
Here you can “select” your preferred FMP.
Enter the “amount” you want to invest and click “Continue” to buy units.
Generally, FMPs has a minimum investment amount of Rs.5000.