In the last few months, both fixed maturity plans and fixed deposits have been competing for investors' attention. Mutual funds have come out with advertisements where they talk about the advantages of investing in FMPs, which include lower taxation and higher returns. Similarly, banks have been flashing hoardings declaring 10.5 per cent or 11 per cent returns. Here we take a look at both these products and how they work.
FMPs, launched by mutual funds, invest in certificates of deposit of banks, commercial papers and bonds of companies and other similar instruments. They offer 'indicative returns' to the investors. FDs are issued by banks and some non-banking finance companies and offer 'assured returns.' FMPs usually offer returns that are slightly higher, around 1 percentage points, than FDs because of their exposure to other instruments. At present, FDs are offering around 10-11 per cent, while FMPs are offering 11-11.5 per cent.
However, the reputation of FMPs have taken a serious hit in recent times because of reports about the exposure of mutual funds to papers of real estate firms and NBFCs. Some funds were even forced to roll over because companies defaulted on their payments.
So FMPs or FDs -- what would be the right choice? Financial planners say that though FMPs have been offering stable returns in the past, caution should be the key word now. "I have been advising short-term FDs for the time being," admits Suresh Sadagopan, director, Ladder 7 Financial Planners. The reasoning is that though returns from FMPs are more attractive, investors in today's market have to be more cautious. Anyway, their portfolios in the equities are suffering because of a sharp fall in the stock markets.
Also, exiting an FD mid-way is much easier vis-a-vis an FMP. For instance, if you have invested in a 180 day FD and exit it in 120 days, the interest payout will be only for 90 days. The rest will be deducted as penalty. On the other hand, exiting an FMP before it matures would mean an exit load of 2 per cent.
As far as tax issues are concerned, it is true that FMPs have tax advantages compared with FDs because returns from FMPs are taxed at a much lower rate. That is, for short-term products, if you opt for the dividend option, there is a dividend distribution tax of 14.28 per cent. Otherwise, returns are considered a part of your other income and taxed accordingly.
What has made FMPs more attractive is the fact that if there is a scheme that matures after a year, the investor stands to get double indexation benefits. For instance, if there is an FMP that starts in February 2008 and matures in April 2009, the taxation will be 10 per cent (without indexation benefits) and 20 per cent (with indexation benefits of two years 2008-2009 and 2009-2010). In case of an FD, returns are added to the income and taxed according to the income slab of the depositor, which obviously is higher.
As far as risk profiles of both the products are concerned, FDs definitely and decisively score over FMPs simply because of the fact that the money is being invested in a bank. If the amount is less than Rs 1,00,000, there is an insurance cover that ensures the depositor will not lose any money.
Also, it is simpler to invest in them because one does not have to go through terms like 'indicative portfolios' and 'indicative returns,' which could be rather confusing if you do not understand the nature of papers the fund house is holding.
Obviously, for the risk-averse and less complicated, FDs are much more secure and stable, despite the higher taxation. However, for the ones who have a higher risk appetite, FMPs are an interesting option. When building a portfolio, remember that an FMP is at best, a portfolio-diversifier, whereas FDs form the stable part.