FMP Vs FDRs

FMP Vs Bank FDRs
With the recent equity market volatility and rising inerest
rates, it is time to think and have an appropriate balance
between equity and fixed income instruments consistent
with one's risk profile and time horizon of the needs.
Fixed Maturity Plans (FMP)
FMPs are quite in fashion now a days - and they all tell
you they're going to save you a lot more tax than bank
fixed deposits (FDs). How?
FMPs are a kind of debt funds. Debt funds are simply
those that invest in debt securities - like Govt. securities,
corporate bonds, corporate rated deposits etc.
· Fixed Maturity Plans (FMPs) are debt funds that
have a fixed term - usually 3 to 15 months, and
· are closed ended, meaning you can only buy in an
NFO, not after that.
FMP Returns are not guaranteed, but usually indicative
returns are reached. Why? Because they buy products at
the same maturity level, and hold till maturity. So an FMP
now may say indicative returns are 10% for a 370 day
period, which involves them buying securities yielding
11% for the period, and holding till maturity. They charge
you about 1% as management fees, so the return to you
is 10%, pre tax.
Tax Advantage
Even if the interest rate goes up or down it doesn't change
the yield for them (since they don't sell or buy the
security). How do they give you lesser tax? Two ways :
1. Double indexation. The gains you make are indexed
over two years (typical indexation rates are 5% a year) so
that you make no gains according to the tax authorities.
That involves buying, say, in March of one year and
maturing in April of the next year. That gives you two
financial years (since years are April-March) of holding,
which means a typical indexation of 10%+ - so you make
10% or so on interest, and the government thinks you
made nothing because of two years of inflation, so you
pay no (or very little) tax.
2. Lower tax rate: All longer term debt fund dividends
are taxed at 12.5% for individuals versus FD interest
being at your marginal rate (say 30%). Note: short term
debt that involves money market and call money is
charged higher dividend rates. Also, capital gains for debt
funds held over a year is only 10% (without indexation)
or 20% with indexation.
Both these are significantly less taxing than FDs, where
the interest is added to your income and taxed at your
marginal rate.
Risk
What's risk with FMPs? Well, the interest rate is not fixed.
You never know how much you'll eventually get. Second,
there is usually some penalty for early liquidation (before
maturity) that can actually erode your capital. If they put
a 1.5% early exit load, and you want to exit in say a
month, the NAV may not have moved enough to cover the
exit load itself, so your capital also goes! This doesn't
happen with FDs.

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