Most of us rarely look beyond fixed deposits while investing in risk-averse fixed-tenure investments. The fact that fixed maturity plans (FMPs) can help earn similar returns while yielding tax benefits too is unknown to many.
Understanding FMPs
An FMP is ideally a closed-ended debt scheme, wherein the debt’s continuity matches the tenure of the scheme. So, this means that a one-year FMP will put money in debt instruments including certificates of deposit, commercial papers, corporate and government bonds, and bank fixed deposits. This concurring maturity obliterates any kind of risk associated with interest rates or reinvestment. While many people may opt to invest in FMPs for returns that are a bit higher than the FDs, the final return is more or less close to earnings on FDs post-deduction of fund management fees.
The liquidity option is, however, less than that in FDs. Unlike the FDs wherein you may withdraw from by paying a small penalty, exiting an FMP may not be that easy. This explains why the investors must put money that they do not need till the maturity of FMPs.
Fund managers managing the FMPs have to speculate on the possible interest rates of financial instruments and then choose those that would yield the highest returns to investors in all likelihood.
Though the FMPs may not earn yields to the same extent as equities, their risk-free and tax-free nature help them stand out among other options. Notwithstanding the holding period, FMPs yield better post-tax returns. Also, unlike other debt funds, most FMPs managers adopt a buy and hold strategy. Since the buying and selling of debt securities in FMPs are less compared to debt funds, the expense ratio of FMPs is relatively lower.
You can choose between two options, viz., growth and dividend options while buying FMPs. Investors choosing FMPs with tenure for more than a year can opt for the growth options, while those buying FMPs only for a year or less can benefit from the dividend options.
Tax benefits on FMPs
The indexation benefits on capital gains tax offer the much-needed respite against rising inflation. Since the capital gains tax is paid only on effective earnings (after applying for the indexation benefit), the post-tax yield would be much higher.
In case of loss, the investor can set off the loss against other long-term capital gains, thus, lowering the tax liability further. There are many FMPs with double indexation benefits too.
Choice of fund house matters
Undoubtedly, FMPs are way less risky. But this does not mean that you must invest in them randomly. The credibility of the fund house issuing the FMPs matters. Though there are no interest and reinvestment risks, the possibility of credit risk is still a point of concern.
Fund houses are refrained from sharing “indicative portfolios”, so there is no way to find out the investment details of FMPs. Investing with experienced fund houses enjoying goodwill is one way to make sure that the money would be parked in high-quality papers.
Bank FDs up to ₹1 lakh come with deposit insurance, which is not available on investing in FMPs, thus, explaining the need to invest with good fund houses.