Here are some guidelines which would help you in comparing Fixed Maturity Plans (FMPs) with Fixed Deposits (FDs):
Suppose you have a goal to finance like buying a car after 3 years. You happen to be a low-risk seeker who is exploring decent investment options. Along with reasonable returns, you also desire a bit of tax-efficiency. A relative recommends you to go to the nearby bank branch and make a Fixed Deposit for 3 years. You find that advice entirely appropriate.
But think again!
There can be better avenues than FDs for your case.
Go for Fixed Maturity Plans instead!
Of course, these are a type of debt mutual funds, and they do carry some amount of risk.
So, is it a viable option?
Absolutely yes. You may earn higher returns along with the benefit of indexation.
Fixed Maturity Plans (FMPs) – An Introduction
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Fixed Maturity Plans are a type of debt mutual funds which are close-ended contracts. The opportunity to invest in them is open for a limited period. Unlike open-ended funds, they are less flexible as regards entry and exit. After a specified duration, the fund matures, and you get back the proceeds at the prevailing NAV. The primary objective of FMPs is to give you stable returns by locking in the invested amount for said duration. Your funds may stay invested for one month to five years depending on the tenure of the fund.
FMPs are ideal investment avenues for investors with low-risk appetite. The fund manager invests in money market instruments like commercial papers, certificate of deposits, corporate bonds, fixed deposits, etc. He makes sure that these securities are highly-rated like “AAA” to keep credit risk at bay. In this way, FMPs offer higher capital protection from the risk of loss as compared to equity funds.
Debt funds are exposed to several risks. One among them is interest rate risk. The interest rate volatility in the economy could adversely affect your fund returns. To overcome this, the fund manager employs a strategy known as hold-till-maturity. He mostly tries to match the maturity of the securities with that of the fund tenure. In this way, the fund can generate steady interest income over the entire investment duration.
Apart from economic and market conditions, your fund returns can be affected by fund-related factors. The most significant among them being the Expense Ratio. Portfolio churning has a considerable bearing on expense ratio of the fund. So, a comparison of FMPs with similar debt funds like Dynamic Bond Funds, reveals startling facts. In FMPs, the fund manager is not interested in frequent buying and selling of securities. Thus, FMPs tend to have a low expense ratio as compared to dynamic bond funds. Such a saving translates into considerably higher returns in your wallet.
FMPs vs. Fixed Deposits- A comparison
FMPs are similar to FDs in some aspects. Both of them have a fixed maturity period and the same level of illiquidity. As liquidation of your FDs before maturity ain’t possible without attracting penalties, a similar thing happens with FMPs also. Liquidity aspect is compromised in case of FMPs. If you want to exit before maturity, you may sell the unit in the stock exchange. But there are a few takers. So, if you want to invest in FMPs, then be prepared to lock-in your funds till maturity.
However, there are stark differences between FMPs and FDs which make FMPs a better investment haven. FMPs enjoy the benefit of indexation when you stay invested for at least 3 years. It means that the capital gains would be taxed at the rate of 20% only. It implies that you earn higher post-tax returns than FDs.
Let’s understand this with the help of an example.
Suppose you invest for 3 years in an FMP and an FD wherein both give you say 9% returns. If you happen to belong to 30% tax bracket, then it can be a life changing experience. After 3 years, the returns in case of FD will be around 6.3%. But FMPs will give you returns to the tune of 7.20%. Earning a post-tax return of around 7.20% ain’t a bad deal at all.
So, you can see that investing in FMPs will leave you comparatively richer than FDs. But here’s a catch. FMPs are riskier than FDs. Moreover, the returns on an FMP are not guaranteed like you have on FD.
However, this can’t be a deterrent for you to invest in FMPs. You can bank upon the prudence of your fund manager. He may give you better returns than FDs.
Also read: Top 5 dynamic bond funds for 2017
FMPs vs. Open-ended Funds- A comparison
You just cannot expect the flexibility of open-ended funds in FMPs. Moreover, in the absence of a goal, there may be an element of reinvestment risk in FMPs. In simple words, you need to have a purpose of using your finances once the FMP matures. If you don’t have one, then you may face the risk of not getting a reinvestment avenues which gives similar returns. Such a risk would be called a reinvestment risk.
Such a risk can be avoided in open-ended funds which don’t have fixed maturities. You may remain invested in them till the need of redemption arises.
The perennial feature of open-ended funds also exposes them to interest rate fluctuations. In the case of FMPs, however, you would be able to escape interest rate risk. In the entire investment duration, the instances of negative returns are quite common for open-ended funds. But such possibilities are very rare in the case of FMPs. You can be assured of not returning empty-handed upon maturity.
FMPs come up with both dividend option and growth option. If you are in the high-tax bracket, then choose growth option for tax-efficiency.
Things to look for before investing in FMPs
There are certain precautions that you need to take to stay safe with FMPs.
1. If your fund house doesn’t indicate the rate of return on FMPs, then check the holdings of the scheme. By looking at them, you can get to know the probable RoI.
2. To give you higher returns, the fund may invest in low-rated high-interest bearing instruments. So, remember to check the ratings of the holdings before investing.
3. It’s better to enter FMPs in an increasing interest rate regime. In this way, you can ensure that your scheme would invest in high-interest bearing securities.
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Final Words
FMPs are good when you have a moderate investment horizon. You would be benefitted by following the precautions and not exiting before maturity.
Mutual Fund investments are subject to market risks. Please consult your financial advisor before investing.
