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Mutual Fund FMPs Fetch More returns than Bank FDs

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Here is your chance as a fixed income investor to earn 10% returns after tax. Probably, it may be your last chance as experts believe that interest rates have peaked and they would start easing soon. Thanks to the tight liquidity situation in the banking system, banks and companies are raising money at a rate of 10-11%. You can cash in on the trend and pocket some handsome returns if you park your money in fixed maturity plans (FMPs), especially those with one-year tenor. There are at least four FMPs from various mutual funds like HDFC, Kotak, open for subscription at the moment. Most FMPs are open for a very short period of time and you can get information about. Fixed maturity plans with 13 months tenure make investment sense due to prevailing attractive yields and double indexation benefit available to investors

Why Invest?

For the uninitiated, fixed maturity plans are closed-ended income schemes that invest in fixed income instruments with maturity coinciding with the maturity of the scheme, thus nullifying interest rate risk. Two factors make investing in FMP an attractive opportunity now. First, attractive interest rates. One-year rates are hovering around multi-year highs, and they are expected to come down soon. Obviously, it makes sense to lock-in your money at the current rate.


We expect lower CD issuances by banks in April compared to March this year. This along with some government expenditure in April would result in money market rates moving downwards. He is not alone.

 

Government expenditure should begin in April. Also . 60,000 crore should come into the system through redemption of government securities in April. This should improve liquidity and bring down interest rates. Put simply, investors may see lower yields in April compared to what are available now. We expect interest rates to come down by 100 basis points over the next one year. Current high yields are a temporary phenomenon caused by advance tax payments and bank borrowing through CD.


The attractive post-tax return is the second reason why you should consider investing in FMPs. If fund managers can park their money at around 10.5%, and if we assume expense ratio of 50 basis points, FMPs should deliver a return around 10%. Your long term capital gain tax liability would be 20.6% with indexation or 10.3% without indexation. If you buy an FMP that matures in FY 2013-14, you are eligible to claim double indexation benefit. Your investment is spread across three financial years and you get indexation benefit for two years. That should effectively bring the repurchase price of scheme units to indexed acquisition cost of unit, making it a zero tax transaction. To ensure this, you have to remain invested in the growth plan of the FMP.

FMP Vs Fixed Deposit

Many would like to point at one-year fixed deposits of public sector banks offering 9.75-10% returns as an alternative investment option available to investors. But a point to note is that interest payable on fixed deposit is taxed at marginal rate of tax. If you are in the highest tax slab you will end up paying 30.9% tax on interest earned. But we have already seen that you may not pay anything towards tax if you are in growth option of a 13-month FMP.


But fixed deposits score over FMPs on liquidity. FMPs are listed on stock exchanges and you may never get to exit at fair value on stock exchanges due to poor liquidity. Many banks have floated special schemes that do not charge any pre-mature penalty to attract money in fixed deposits. This is especially true in 7 days to 200 days fixed deposits. So if you are really not sure whether you can remain invested throughout the tenor of an FMP, avoid investing in the same, no matter how attractive the proposition is. But if you are sure of your cash flows and want higher post-tax returns compared to fixed deposits, a 13-month FMP makes a lot of sense.

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