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FD’s or FMP’s?
While FMP’s have a hard lock-in (there’s no option available to encash your money prior to the maturity of the fund), FD’s provide options for quick and easy withdrawals using net banking.
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Over the years, FMP’s (Fixed Maturity Plans) has emerged as a viable alternative to FD’s (Bank Fixed Deposits). FMP’s are a category of ‘pure accrual’ debt fund, meaning that once they construct their portfolio by purchasing bonds on your behalf, they will not liquidate them midway but rather hold them until maturity. In addition, they are ‘close-ended in nature, meaning that one can only subscribe to their units during the NFO (New Fund Offer) period which could last for up to a week.
The recent fall in deposit rates now means that FD investors will earn less than 5 per cent per annum or so on their savings – the returns are taxable to boot. In such times, low-risk-taking investors are on the hunt for similar, low-risk avenues to park away money. If you’re one of them, you may be considering FMP’s. Here’s a comparison of how they fare against deposits on various fronts.
While FD’s provide returns that are guaranteed by the bank, FMP’s do not. Until 2009, they used to provide an ‘indicative yield’, but SEBI did away with this practice as it was leading to mis-selling by some distributors who touted this as a ‘guaranteed return’. FMP’s do, however, publish an indicative portfolio break-up between AAA bonds, AA bonds, and the like. From this, one can indirectly derive an expected return – for example, if 3 years AAA’s on average are yielding roughly 5.1% these days, and 3 year AA’s 5.5 per cent, a 3-year FMP that divides its portfolio equally between the two rating categories will likely provide around 5.25% returns. In general, FMP’s provide between 50-75 bps higher returns than FD’s of equivalent tenures – however, this isn’t a guaranteed number.
FMP’s are exposed to the risk of one or more of their underlying papers defaulting (credit risk), and this could potentially hamper their returns. They are also exposed to a risk known as ‘reinvestment risk’ – that is, the risk that the fund manager will need to reinvest maturity proceeds at a lower than earlier rate. Generally speaking though, FMP risks are well managed, and the chances of default are miniscule as they typically hold highly rated papers. However, FD investors need to be aware that such risks exist – and this is the price to pay for the higher returns.
FD’s fare better than FMP’s on the liquidity front. While FMP’s have a hard lock-in (there’s no option available to encash your money prior to the maturity of the fund), FD’s provide options for quick and easy withdrawals using net banking. Encashing an FD prematurely will entail sacrificing returns though, as the interest will be pro-rated to your final holding period.
FMP’s fare better than FD’s on tax efficiency, provided that the FMP tenure exceeds three years. Returns from FMP’s with tenures not exceeding three years are taxed exactly as Fixed Deposits (short-term capital gains, clubbed with your income for the year). Returns from FMP’s with tenures exceeding three years are indexed for inflation and taxed at 20% flat, and this brings down the tax outgo significantly.
Although it may not seem like it, FD’s vs FMP’s is really an ‘apples to oranges comparison. Both have varying risk profiles and liquidity options. One is a bank guaranteed deposit, while the other is essentially a portfolio of ‘held to maturity bonds. As an investor, you need to think carefully about which one suits you best. If the hard lock-in bothers you enough to be willing to sacrifice 1% returns or so (not guaranteed), go for FD’s. If you’ve got a 3-year horizon and are absolutely certain that you won’t need any interim liquidity whatsoever, go for FMP’s as they will fetch you a significantly higher 3-year, post-tax return. As with all investments, consider your unique situation and preferences before you sign above the dotted line!