Long-term FMPs still a better bet than FDs

Despite indicative yields falling, they beat the latter in post-tax returns

MUMBAI: That indicative yields on fixed maturity plans (FMPs) have dropped is well known by now.

Even then, the post-tax returns on long-term FMPs, with a duration of 18 months, work out to be much better than the good old fixed deposits (FDs). The post-tax returns, depending on which FMP you choose to invest in, currently stands at around 7.5%.

FMPs are closed-ended mutual fund (MF) schemes with a fixed maturity date.  The post-tax return on an 18-month FD currently stands at around 5%. This is much lesser than the post-tax returns on FMPs.

This is primarily because the current tax regulations work in favour of FMPs. The interest earned on an FD is not tax-free and is taxed as per the tax bracket an investor falls into. With the highest tax bracket now being 33.99%, almost one-third of the interest earned on an FD will have to be paid as tax by those who fall into this bracket.

Even those who fall into lower tax brackets are better off investing in FMPs as the accompanying tables clearly show.

In case of an FMP of more than one year, tax has to be paid on the long-term capital gain. Long-term capital gain is taxed at 20%, with indexation or at 10% without indexation. On this, surcharge as well as education cess is applicable.

However, investors should bear in mind that FMPs carry more risk than FDs. Unlike an FD, where returns are guaranteed, in an FMP, the returns are only indicative. An MF cannot guarantee returns.

An FMP, like an FD, has a certain maturity. Given this, an FMP which matures in 18 months, will look to invest in securities that mature in 18 months. At the time of launching the FMP, depending on the return securities maturing in 18 months give, the MF gives an indicative yield. The money collected by an FMP is invested in securities of a similar maturity. The securities mature after 18 months and so does the FMP. Hence, FMPs involve a very passive style of investing.

However, there are chances that the fund house may not able to meet the indicative yield. The primary reason is that it may not be able to find enough securities of a similar maturity to invest in. Hence, returns are indicative and not guaranteed.

But to make an FMP attractive, a fund house may project a higher indicative yield.

If an MF wants to make an 18-month FMP attractive, it can offer an indicative yield of 9%. To meet this yield, it will have to generate a greater return. One way of doing this is to invest in debt securities, which are riskier and hence promise a greater return. These  reasons make an FMP riskier than an FD.