Monday, January 13, 2014

FDs vs FMPs-What is better?




We are sure that you as an investor must have come across this dilemma as to what to choose from – a Fixed Maturity Plan (FMP) offered by a mutual fund house, or a Fixed Deposit (FD). Well it’s confusing for an investor because both of them start with the word ‘Fixed’. So, now let us understand what exactly a FMP is and how it is different from a FD.

A Fixed Maturity Plan is a close-ended fund that invests in debt and money market instruments of similar maturity as the stated maturity of the plan. That means a 90 day FMP will invests in debt and money market instruments which mature in 90 days like 3-month Certificate of Deposits (CDs), 3-month Commercial Papers (CPs) etc. An interesting point to be noted here is that unlike a FD where your maturity amount is fixed, in a FMP only the period or time horizon of the fund is fixed. As such a 90-day FMP will cease to exist on maturity.

The distinguishing feature of a FMP is its indicative return unlike a FD where you know the fixed amount receivable at the end of the maturity period of your FD. So a 90-day FMP at a time where 3 month would not tell you what interest it would yield, but internals may provide you an indicative yield. This means at maturity there is a possibility of deviation from the indicative yields given at time of open offer period, while investing.

One can Invest in FDs anytime whenever the surplus is available , while to invest in FMPs one can invest only at the time of New offer period.

As far as investment tenure in concerned, both have various maturity options available for the investors.

Which is better from taxation prespective? In an interview to CNBC-TV18 personal finance expert Lovaii Navlakhi of International Money Matters explained the difference between Fixed Deposit (FD) and Fixed Maturity Plan (FMP).

He also spoke about the advantages and disadvantages of the same. The advantage of investing in a FD is that one can invest in it at any point of time and can also encash it, whereas FMP is illiquid, but has a tax benefit. One should compare the returns from fixed income products from tax implication point of view, he suggested.

FAQ: How can an investor best evaluate the advantages of a bank fixed deposit (FD) versus a fixed maturity plan (FMP)?
          There are few basic differences and for that we need to understand as below:
The bank FD is a very simple product. Firstly, if I invest upto Rs 1 lakh, I know the rate of interest at the time of investing in that product. If one is a senior citizen or the amount is large then the rate of interest is higher. Secondly, I can invest in a bank FD at any point of time whenever money is available to me. The FMP is advantageous from a tax point of view but disadvantageous from liquidity point of view that is you cannot encash it, though some FMPs are listed on the stock exchanges. Extending this comparison of FD versus FMP further; in any fixed income product the important thing is to compare the returns for the same period and also look at the tax implication. To give a simple example, for somebody who is in a 30 percent tax bracket and has invested in a bank FD, and is getting 10 percent per annum return then he is actually getting 7 percent post tax return. Versus that let us for somebody who has invested in an FMP for more than a year, which is giving 8 percent return then on the face of it, it looks like it is much lower than an FD. But because the FMP is more than one year, and I take the growth option; I will pay capital gains tax long-term of 10 percent and my rerun on that FMP is then 7.2 percent, so it is higher than the bank FD. There are some complications but if you compare it in this manner you will understand what is better for you.

In FDs , interest income is added to investor’s income and is taxable as per income slab also known as marginal rate of tax. With FMPs tax implication also depends upon the option of investment viz, Dividend or Growth. In Dividend option investors have to bear the dividend distribution tax(DDT).In 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(i.e. if investment is for less than 365 days),the interest income is added to the investor’s income and is taxed at marginal rate of tax. As for as longterm capital gains (means if investments are held for more than 365 days),the tax liability is based on lower of with indexation(charged at 20% plus surcharge) or without indexation (charged at 10% plus surcharge).With indexation benefit FMPs work out to be more tax efficient investments as compared to FDs.



Above illustration is just for better understanding purpose only and is old chart, so rate of tax, yield taken etc is not relevant, but will surely give an idea of how both can be compared in terms of returns after tax.

FAQ: One would want to know, which is the big season for FMPs? How do you choose between FMPs?

               The season is more to do with availability of underlying product. We must understand that when the FMP is being offered to you by the mutual fund, in turn they have identified where they are going to invest the money. Typically, if they are offering to you, let us say a 13 month FMP; they have to have products which are maturing in 13 months. Otherwise, there will be a big asset liability mismatch. Ideally, if you want to select a FMP, you should know what the underlying investments are? They are investing in which particular instrument? And whether there is any risk in those instruments etc? But the regulation does not allow mutual funds to share their portfolios in advance. So, to that extent it becomes a little bit of a black-hole. It is only the advisor, who can have a communication with the mutual fund house and understand what type of investments the mutual fund house is making although they won't know the specific names or the types of investments. Then based on the risk, the advisor can recommend it to his clients.

 FAQ: Looking at long-term objective of wealth creation, one would want to know how much of ones portfolio should he/she be investing in fixed income products like fixed maturity plan or fixed income mutual fund. And is there any need to keep money in bank FD or has it become irrelevant now?

                 The first thing for you is to determine what is the amount of monthly expenses you incur? Now, if one is a new investor keep two month expenses in your bank. Then take another one month expenses and put it in bank FDs. A bank FD is not irrelevant and we should have some money there where one is sure of rate of return. Then take maybe another three months expenses and put them in liquid funds or Ultra short Term funds. So, basically when you start to invest, you ensure that you are not going to face a crisis for your short-term needs and that you are not putting all the money in the equity markets and suddenly realising that you are losing a lot of money. Once that is done then the money that I have with me are for my long-term needs or for my goals that are going to occur from time to time in future. Depending on those goals, your advisor will suggest to you on your asset allocation?

Now that we have known basics of FMPs let us get little more deeper into the product and practicality.



FMP NAV and Asset Composition quality

Fund companies declare the NAV of their respective FMPs , which can be found on their websites, and they also declare half-yearly results which has a list of assets they own. 

Another important and little paradoxical point is while no one asks banks where they invest when some amount is invested in an FD, at the same time if some amount is invested in FMPs one needs to research and know where it is invested. While the portfolio is not declared at time of investing, but later you can check the same on AMCs websites for the portfolio composition. However, FMPs invest in high quality instruments, which are rated by atleast one rating agency.In lot of cases one would see that the amount that you have invested in FMPs are inturn lended to lot of Banks sometimes and still the FMPs give near to similar returns as to FDs. Though looking for,comparing, understanding and assessing the composition of the portfolio is not that a regular investor be able to do, atleast one should know where it is available.

The yields of the underlying instruments (such as CDs, commercial papers, bonds) at the time of offer is either mentioned in the offer document or can be checked in public websites. You will also do well to know if the FMP promises to invest in top-rated instruments and whether it takes any credit risk by going for instruments with mediocre credit rating. In 2008 - 2009, for instance, some FMPs had invested in debt instruments of real estate companies. At that point of time with the sector was going into liquidity crunch and  the investors felt jittery for the risk of default. 

Currently one can look for FMPs for short term and/or about a year’s time over the next few weeks. Note that FMPs are often open for a day or couple of days and do not reopen for investments. Hence, you will do well to keep tab of new offers, If you wish to invest. It is generally observed that, as and when March season arrives the short term FMPs may yield higher returns atleast on the shorter curve i.e. for shorter term.

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