Consider FMPs for higer post tax returns
It was not long ago when fixed maturity plans (FMP) was a preferred investment instruments for large companies and high net-worth investors but today it has found takers in retail investors. Of late with the government trying to stem fall in rupee there has been liquidity tightening measures which led to the increase in short-term rates making FMPs more attractive. Taking a cue of this most fund houses have launched new fund offers (NFO) of fixed maturity plan (FMP) debt funds to lock into higher rates. Those who are looking for short-term investments can consider FMPs. Let’s see what are FMPs and if you should invest in them.
FMPs are close-ended mutual funds and look similar to a fixed deposit. You can invest in them during the new fund offer (NFO) period which is fixed or you can buy FMPs from the secondary market as these are listed in the exchange. FMPs invest in debt instruments which have a maturity that coincides with the maturity of the FMP. FMPs invest mostly in short-term debt instruments such as certificate of deposits (CD) from banks, commercial paper (CP) issued by companies, money market instruments, corporate bonds or in securities issued by government of India and fixed deposits. The tenure of investment could be 30, 90,180, 365 days or more. The minimum investment amount is usually Rs 5,000, which a retail investor can easily invest.
Maturity:FMP invests in securities that will mature more or less on the same time making it less sensitive to fluctuations in interest rate. So there is no interest rate risk for an investor holding an FMP till maturity. Since FMPs are closed ended and you cannot redeem units with the mutual fund during the FMP tenure, the fund manager need not sell any part of the portfolio during this tenure thus locking the yield of the portfolio. This also reduces the risk of loss on premature sale of securities and lowers the interest rate risk.
Lower cost:If we look at the expenditure on fund management then it involves minimum cost as there is no requirement for a time-to-time review by fund managers to buy or sell the instruments constituting the fund. Since these instruments are held till maturity, there is a cost saving in respect of buying and selling of instruments.
FMPs are comparable to FDs. Let’s consider how FMPs are placed better than FDs.
Liquidity: The liquidity in case of FMP is nil. In order to exit an FMP you will need to sell units to a buyer on the stock exchange where the instrument is listed. Although listed in exchange but it is poorly traded. And with no liquidity on the stock exchange, investors looking to exit will stuck. Banks mostly allow premature withdrawal of fixed deposit with little penalty.
Offers post-tax benefit over an FD
In an FD, the interest is added to the other income and taxed at applicable slab rate while in FMPs the tax implication depends upon the investment option dividend or growth. In the dividend option, investors have to bear the dividend distribution tax (DDT).In the growth option, returns earned are treated as capital gains (short-term or long-term depending on tenure).
FMPs qualify as a long-term capital asset if holding period is minimum one year. Long-term capital gain tax is 10.3% without considering benefit of index or 20.6% with benefit of cost inflation index, whichever is lower hence FMPs will give you a better post-tax yield compared to a FD.
For example if you invested Rs1 lakh on 7th Aug 2012 in a 370 days FMP and value of your investment is Rs1.10 lakh at maturity on 12th Aug 2013. CII for FY12-13 is 852 and FY13-14 is 938.
Calculation:
Without considering the benefit of Cost Inflation Index
Purchase Price: Rs. 1,00,000
Sale Value: Rs. 1,10,000
Gain Rs. 10,000
Tax @10% : 1,000
Education Cess @3%: Rs. 30
Total Tax Payable Rs. 1,030
After considering the benefit of Cost Inflation Index
Purchase Price: Rs. 1,00,000
Indexed cost of acquisition =(
1,00,000*938 / 825)= Rs. 1,10,211
Sale Value: Rs. 1,10,000
Long Term Capital Gain/ Loss: Rs. 100000- Rs. 110211 = -211
Since there is a loss after considering benefit of index hence you don’t need to pay tax and the loss can be set off against other long-term capital gain or can be carried forward to the subsequent year. It means if you had invested in FD you would paid a tax of Rs3,090 (considering income is above Rs10 lakh for FY13-14 and you fall under 30% tax bracket) compared to nil tax in case of FMP with same returns. With the indexation benefit, FMPs end up delivering more tax efficient returns than FDs.Aside from the attractive yield, for investors in the higher tax bracket, FMPs also deliver a better post-tax return than bank deposits.
Double indexation benefit
You can also enjoy the benefit of double indexation if the investment stretches through three financial years. For instance if you invested in a FMP on 30 March 2012 and redeemed it in on 1 April 2013, though you held the investment only for 367 days but because the amount was invested in FY 2011-2012 and redeemed in FY 2013-2014 hence there is double index benefit.
Though FMPs offer you certain benefits over an FD but remember that FMPs carry credit risk as there is a possibility of default by the debt issuing company unlike FDs which have minimal risk and investment up to Rs1 lakh is insured by Deposit Insurance and Credit Guarantee Corporation (DICGC). Always invest in credible fund houses that will invest in AA or above rated paper.
