FD or FMP - where to put the money?

MUMBAI: Bank fixed deposits (FDs) of one-year maturity currently offer 8-9% interest.The indicative yields on fixed maturity plans (FMPs) of mutual funds with a maturity of one year are in the range of 8-8.5%.

So are the returns similar? No they aren’t, for differential tax treatment essentially ensures that post-tax returns of FMPs for investors in the higher tax brackets (20.6%, 30.9% and 33.99%) are higher than those from FDs.

As Swapnil Pawar, director, PARK Financial Advisors Pvt Ltd explains, “Interest earned on an FD is treated as other income and hence taxed at a marginal tax rate… typically around 34% for investors with incomes larger than Rs 10 lakh per year. At the same time, effective yield on FMP is treated as capital gain and is taxed at minimum of 10% of absolute gains, or 20% of indexed gains.”

Hence, if a one-year FD gives you an interest of 9%, and if you fall in the top tax bracket of 33.99%, the actual return on the FD is only 5.94%. The balance needs to be paid as income tax.

At the same time, the return on an FMP is categorised as a capital gain.

For one year or more, it is taxable at the rate of 10% without indexation or 20% with indexation, whichever is lower. As can be seen from the accompanying table, the post-tax return on a one-year FMP with an indicative yield of 8.25% is around 7.43%, considerably higher than the effective return from FDs for individuals falling in the higher tax brackets.

Says Suresh Sadagopan, a certified financial planner who runs Ladder 7 Financial Advisories: “Even at an interest rate of 9.5% on an FD, the post-tax return rate is 6.27%. In contrast, FMP returns are in the region of 7.4-7.75% post-tax, which is attractive indeed.”

However, for individuals falling in the lower tax brackets (0% or 10.3%), the returns on fixed deposits are higher than those from FMPs.

Also, investors should keep in mind the fact that FMPs carry more risk than FDs.

“The yield on an FMP is indicative and not guaranteed, as is the case with an FD,” says Pawar.

A mutual fund, by regulation, is not allowed to guarantee returns. An FMP, much like an FD, has a certain maturity. Given this, an FMP maturing in one year, looks to invest in debt securities maturing over the same timeframe.

At the time of launching the FMP, depending on the return securities maturing in one year are giving, the mutual fund gives an indicative yield.

However, there is a risk that it may not be able to meet this indicative yield, if it can’t find enough securities of similar maturity to invest in.

Also, chances are that the securities it invests in would go bad. Hence, returns are indicative and not guaranteed.

Lately, in a bid to make their FMPs attractive and boost the assets under management, some mutual funds have been offering a higher indicative yield on their FMPs. Logically, to meet this yield, the mutual fund will have to generate a greater return.

And one of the ways of generating a greater return is to invest in debt securities, which carry more risky and hence promise a greater return.

Says Sadagopan: “In the interest of higher returns, the fund manager could choose investments which may not be top grade and hence expose the FMP to more risk.” “If someone is jittery on this, he should stay away,” he adds.