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FMPs are good Investmetns over FDs in terms of tax efficiency

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As these funds invest in highly-graded instruments, there is some amount of certainty about returns

FIXED maturity plans (FMPs), the close-ended debt mutual fund schemes, are often regarded as an alternative to bank and company fixed deposits (FDs).

For long, due to the lack of clarity on returns that these FMPs would generate, they failed to gain enough popularity among retail investors.

However, with passage of time, these FMPs have managed to establish a place in the portfolios of a section of smart debt fund investors.

There are investors, who, at times, do away with FDs and replace them with FMPs.

In some ways, FMPs and bank FDs are similar in nature, particularly in the sense that both give you assured returns. This is, however, notwithstanding the fact that the return from bank FD is fixed and also insured up to Rs 1 lakh, and one knows exactly what one will get and when, whereas, in case of FMPs, the returns are only indicative.

Many FMPs do invest in highly graded instruments and therefore, one can say there is some certainty over returns. Some financial planners and investors brand FMPs as the mutual fund industry version of FDs.

While banks and companies can tell investors what they will pay, mutual funds cannot declare the yield on close-ended debt schemes.

They were earlier also barred from disclosing the indicative portfolio of these schemes. Therefore, there has always been and will always be a debate in the minds of an investor whether to go for FDs or FMPs.

There is no doubt that the Reserve Bank of India (RBI)'s credit policy pronouncements on Friday will render the FD-versus-debt fund debate fiercer. Investors will still face compelling reasons why they should invest in FDs, now that their rates are showing a tendency to firm up. At the same time, investors will have convincing arguments in favour of managed products -short-term debt funds and FMPs which are just showing signs of superior yields.

While the choice becomes a tad more difficult, the lure of assured returns will be stronger indeed -in a market where equity and several other asset classes are failing to satisfy the appetite of investors, chiefly on account of high volatility and negative growth

Analysts think the apex bank, which has signalled a firm policy stand on taming inflation, will have a tough task insofar as the debt market dynamics are concerned. The fixed-income scenario is not likely to change suddenly to accommodate sharper yields.

However, a modification of sorts may be expected.

Investors will keep a particular vigil on trends that may emerge in terms of the shorter end of the curve.

There are already apprehensions that as for FDs, the fight between issuers to get a higher share of investors' allocations will turn uglier. Already banks are aggressively offering deposits (with friendly tenure), and investors have started expecting rates that are closer to 10 per cent.

If someone recommends opting for FMPs, one must ask oneself what is so appealing about FMPs and one should make a conscious decision after clearly knowing the differences between FD and FMP .

There are differences between the two on the taxation front as well. If one invests in an FMP, the dividend is tax-free in the hands of the individual investor, but the fund has to pay a dividend distribution tax. If one invests in the growth option of the FMP for less than a year, the gains are added to the investor's income and taxed at the investor's slab rate. In FDs, the interest income is added to the investor's income and is taxable at the applicable tax slab, also known as the marginal rate of tax.

With FMPs, the tax implication depends on the investment option -dividend or growth. While in the dividend option investors have to bear the dividend distribution tax, in the growth option, returns earned are treated as capital gains (short-term or long-term depending on the investment tenure).

In the case of short-term capital gains (if investments are held for less than 365 days), the gains quantum is added to the investor's income and is taxed at the marginal rate of tax. As for long-term capital gains (if investments are held for more than 365 days), the tax liability is determined based on the lower of with indexation (charged at 20 per cent plus surcharge) and without indexation (charged at 10 per cent plus surcharge).

With the indexation benefit, FMPs end up delivering more tax efficient returns than FDs.

There are many, who think that FDs have an edge over FMPs in liquidity. Being fixed income in nature, there are restrictions on liquidity in both cases. But FDs can generally be withdrawn without penalty or with low penalties, unlike FMPs.

The ultimate analysis, managed products are likely to have an edge, because of the possibility of their scoring more in terms of pure returns. On last count, FMPs are known to have offered 10-11 per cent or thereabouts. The trend, if persists, will ensure more conversions from fixed deposits to debt funds. As always, investors need to consult their financial planners before taking active calls in this direction.

In FDs, the interest income is taxable at the applicable tax slab, also known as the marginal rate of tax In case of FMPs, the tax implication depends on the investment option -dividend or growth While investing in the dividend option, investors have to bear the dividend distribution tax

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