The point raised was whether FMP ( Fixed maturity plans ) or FD ( Fixed deposits) who offers best returns ?
Lets try to understand the fundamental difference and similarities between them before jumping to the conclusion.
- FMPs are issued and managed by mutual funds while bank fixed deposits are managed by banks
- While bank fixed deposits (FDs) are deposits in bank debt instruments
FMPs are debt instruments managed by mutual funds in typically Govt backed securities, and corporate fixed deposits.
The fundamental similarity between FMPs and bank fixed deposits is that both FMPs and Bank FDs are both close ended- both fixed maturity plans and FDs have a definite maturity end date
For example, all of us are aware of fixed deposits offered by banks that are of 6 months , 1 year , 2 years or 5 years maturity. Similarly, fixed maturity plans (FMPs) have a definite end date that could range from a month to a few years
Also, both FMPs and bank FDs (fixed deposits) are fundamentally debt instruments that typically (more about that later!) do not have an equity component
FMPs offer better post tax returns than bank fixed deposits (FDs)
( More realistic if the investment is greater than 1 year)
Taking a hypothetic example :
|Tenure of FMP||370 days|
|Indexation rate (assumed)||5.00%|
|Long term Capital Gains tax rate||22.66%|
|The benefit of indexation for a FMP investor|
|Amount invested (assumed) (Rs)||100,000|
|Cash receivable on maturity; total interest @ 9.30% (Rs)||109,513.24|
|Indexed cost (Rs)||105,000.00|
|Taxable income (Rs)||4513.24|
|Tax payable (Rs)||1022.7|
|Post tax return (assumed)||8.30%|
As the above table shows, even if the FMP has a small indicative yield of 9.3%, the post tax yield for the Fixed maturity plan is 8.3%.
Comparatively, the post tax yield for a similar bank FD yielding pre-tax benefits of 9.3% will be yield post tax just 6.3% , at the highest tax slab.
The Risk Factor :
Fixed maturity plans managed by mutual funds typically lock in their debt investments at the time of the FMP issue, there is the risk of corporate debt default, especially , if the investment in FMPs is of non AA or non AAA rated securities
However, in these times of even banks potentially failing, the risk of corporate debt default is minor, if the FMP invests in AAA and AA rated securities.
Happy investing 🙂