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When investing money for a year which is a better option - MIP, fixed deposit or FMPs? In this article we give an insight.
Fixed deposits
Better than savings account are the other investment options like bank fixed deposits schemes. One can invest in a FD with varying maturities.
If he needs certain amount of money after 1 year, he can invest in for 1 year FD for that much amount and for other amount can have FDs of different maturity.
This will help him meet the liquidity needs and also earn interest. He can go for the regular returns options like the quarterly or half-yearly payout options. Else, he can choose interest re-investment option.
However, remember that interest income earned in FD and savings account is taxable.
FMPs
Fixed Maturity Plans (FMPs) are income/debt schemes giving a fixed return over a period of time. They are actually similar to fixed deposits in banks. The maturities offered were varied, going from one month to three years. They are close ended schemes, which are open only for a fixed period of time during the initial offer. While the money is locked, FMPs give the investor an option to exit, which is subject to an exit load as per the funds regulations.
While similar to FDs, there are certain differences. While the returns on FDs are assured, returns on FMPs are indicative as there is a possibility of the actual returns deviating from what has been indicated to investors at the time of investing. The instruments are held till maturity, thus not getting affected any interest rate fluctuations.
The schemes have low credit risk as investments are mainly done in AAA or P1+ rated instruments with a short-term maturity profile. Further, it has minimal liquidity risk as they invest in short-term instruments, which give them adequate liquidity. Also the churning cost is very low as the instruments are held till maturity.
Taxation of FMP depends on the investment option. In the dividend option, investors have to bear the Dividend Distribution Tax. In growth option, returns earned are treated as capital gains- i.e. if investments are held for less than a year, than the interest income is added to the investor's income and is taxed at the marginal rate of tax.
As for long-term capital gains, the tax liability is computed using two methods i.e. without indexation (charged at 10% plus surcharge) and with indexation (charged at 20% plus surcharge) and). The tax liability will be the lower of the two.
FMP Yield: 9.30%
Tenure of FMP: 370 days
Indexation rate (assumed): 5.00%
Long term Capital Gains tax rate: 22.66%
The benefit of indexation for a FMP investor
Amount invested (assumed)(Rs): 100,000
Cash receivable on maturity; total interest @ 9.30%(Rs): 109,513.24
Indexed cost(Rs): 105,000.00
Taxable income(Rs): 4513.24
Tax payable(Rs): 1022.7
Post tax return (assumed): 8.30%
source : http://www.fixedmaturityplans.com%
This 8.3% is more than the 6.25% to 6.5% offered by FD's
However, on the flip side, there are no fixed returns in FMP's. It can be lower than what was indicated earlier. Further, here is usually some penalty for early liquidation (before maturity) that can lower or even erode your capital. And one cannot invest anytime in FMPs as they are not available anytime you want them.
Mutual Fund MIPs
They are hybrid instruments that invest some portion (around 5 %-20 %) in equities and the balance in debt and money market instruments.
It provides monthly income to investors depending upon monthly, quarterly, half-yearly and annual options selected by the investors. MIPs aim to provide investors with regular payouts in for of dividends.
However, it is not mandatory for the funds to declare dividends and is subject to availability of distributable surplus.
While there is growth option to available in MIP, the return will not be in form of dividend but capital appreciation. Some portion of the funds is invested in equities. This provides impetus to the returns while retaining the safety from the debt investments.
It is like icing on the cake and would generate higher returns than the debt fund, albeit with a little higher risk. MIPs are launched with the objective of giving monthly income to investors. MIP is better for investors who are nearing retirement. MIP's appeal to conservative as well as risk taking investors.
Risk in MIP's: The debt portion is influenced by the interest rates. When the interest rate falls, the NAV rises as price of bond increases. When interest rate rises, NAV falls. At such times the equity portion of the fund helps to maintain the returns.
While equity portion makers it more risky than the pure debt fund, they are better than the balanced fund where investment in equity is to the extent of 40% to 50%. And with Indian markets expected to do good in the long term, MIPs would stand to gain.
On the tax front, they are better than FDs as dividends are tax free in the hands of investors, while interest on FDs is taxable.
Thus considering one's risk bearing capacity and investment objective, one can decide on either of these three investment avenues.
| Particulars | Investment in Fixed Deposit | MIP (15%) | MIP (20%) | ||
| With Indexation | Without Indexation | With Indexation | Without Indexation | ||
| Amount Invested | 100,000 | 100,000 | 100,000 | 100,000 | 100,000 |
| Indicative Post Expenses Yield * | 7.00% | 8.00% | 8.00% | 8.80% | 8.80% |
| Tenure (No. of Days) | 1,095 | 1,095 | 1,095 | 1,095 | 1,095 |
| Earning | 121,000 | 124,000 | 124,000 | 126,400 | 126,400 |
| Gains | 21,000 | 24,000 | 24,000 | 26,400 | 26,400 |
| Indexation Rate for 1st Year ** | Nil | 5.00% | Nil | 5.00% | Nil |
| Indexation Rate for 2nd Year ** | Nil | 5.00% | Nil | 5.00% | Nil |
| Indexation Cost ** | Nil | 10,250 | Nil | 10,250 | Nil |
| Long Term Gains/Losses | Nil | 13,750 | Nil | 16,150 | Nil |
| Tax Rate | 33.99% | 22.66% | 11.33% | 22.66% | 11.33% |
| Tax Payable | 7,138 | 3,116 | 2,719 | 3,660 | 2,991 |
| Post Tax Gains | 13,862 | 20,884 | 21,281 | 22,740 | 23,409 |
| Post Tax Annualized Return | 4.62% | 6.96% | 7.09% | 7.58% | 7.80% |
Six smart things to know about Monthly Income Plans (MIPs)
1) MIPs are schemes created by mutual funds that seek to generate regular income. There is no guaranteed rate of return.
2) MIPs invest primarily in debt instruments, but hold a small portion in equity (between 5 and 35%), to enable growth in investments.
3) Investors can choose from growth and dividend options in an MIP, depending on their need and tax status.
4) Investors choosing a growth option can redeem a part of their units regularly using a systematic withdrawal plan to generate regular income.
5) Withdrawals are subject to capital gains tax, but an investor who falls in the tax-free or low-tax category, can use it to reduce his tax outgo.
6) The dividend distributed by an MIP is tax-free in the hands of the investor, but is given after a dividend distribution tax has been paid directly by fund.
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