Get a FREE e-course "Basics of Personal Finance"

           
  • Income Tax: Rules, Forms (ITRs), Filing
  • Investments: Stocks, Mutual Funds, ULIPs, Gold, Real Estate
  • Insurance: Term Insurance, Endowment Plans, ULIPs
  • Loans: Home Loans, Auto / Car Loans, Lease, Hire Purchase

Name:

Email:



Understanding a Fixed Maturity Plan (FMP)

Fixed Maturity Plans, or FMPs, have become quite popular among conservative investors not wanting to invest in asset classes considered risky. FMPs have emerged as an alternative to fixed deposits (FDs).

What is an FMP? How do FMPs work? What are the risks involved? Are there any income tax benefits?

[Article inspired by a query from reader Vijaya]



In recent times, many people have started investing in Fixed Maturity Plans, or FMPs. FMPs have been positioned against bank fixed deposits (FDs) as safe investments giving better returns than FDs.

(Please read “A comparison between bank FD and FMP: FD versus FMP” for a detailed comparison between FMPs and FDs)

But what actually are FMPs? Where do they invest? Are they right for you? Let’s find out.

What are Fixed Maturity Plans (FMPs)?

Fixed Maturity Plans are offered by mutual funds (MFs). It is a type of debt mutual fund.

You invest money in the FMPs for a fixed duration, just like bank FDs – the units of this plan mature on a predefined date (and therefore the name Fixed Maturity Plan). In this respect, these are close-ended schemes. The maturities usually range from one month to three years.


The money collected from you is invested in fixed-income instruments. It can be Commercial Paper (CP), Certificate of Deposit (CD), money market instruments, corporate bonds and even bank fixed deposits.

To a large extent, the money is invested in debt issued by various companies.

Typically, the debt issued by companies offer a higher rate of interest compared to bank FDs. Thus, the returns offered by FMPs are usually better than bank FDs.

Expense Ratio: FMPs usually have expense ratios between 0.25% and 1%.

Exit Load: FMPs invest for a fixed tenure. So, stability of funds is important for them. Thus, to discourage early redemptions, the exit load is usually high – anywhere from 1% to 3%.

How do Fixed Maturity Plans work?

FMPs invest most of their money in debt instruments (also called “paper”, at times) issued by companies.

These instruments for investment are chosen in such a way that they mature around the same time when the units of the FMP are supposed to mature. These debt investments are usually held till maturity.

This means that there is no buying and selling of the debt by the FMP. Due to this reason, there is not much price risk (possibility of a loss if the debt is sold at a price lower than its purchase price).

At the time of purchasing the debt itself, the fund manager knows the return he would get from the investment, as the coupon rate (or the rate of interest on the debt) is known.

For this reason, FMPs are considered to be relatively safe.

This lock-in rate is often presented to investors as the “indicated return” or “indicative return”. Remember, this return is not guaranteed – but the fund manager expects to earn that much return based on the investment made.


Credit Rating and Safety

Various debt issues are rated by credit rating agencies. Depending on the financial health of the companies issuing the debt, the debt instrumented is given a rating that indicates the risk associated with it.

As a rule of thumb, the riskier the debt, the higher is the return on it.

FMPs invest in debt having different levels of risk. But they usually stick to relatively low-risk debt issues.

Are Fixed Maturity Plans totally safe?

So, what does all this mean?

If the FMPs invest in relatively safe debt, and hold it till maturity so that the return from the investment is known beforehand, does that mean that FMPs are risk free?

Well, theoretically, they are very low risk. Of course, the overall risk depends on the type of debt they are investing in. But good FMPs investing in highly rated debt (say, AAA or AA rated debt issues) are normally considered very low risk.

The problem is that even if the return is locked-in at the time of investment, there always remains the default risk – the possibility that the company issuing the debt would not be able to repay the principal amount.

True, the rating given by the credit rating agencies largely takes care of this, but at times, there can be sudden changes in the company’s financials (or the economy in general) that would result in a default by the debt issuing company.

For example, recently, many FMPs had invested their money in debt issued by real estate companies that were considered very safe. Suddenly, the market scenario has changed, and many supposedly “safe” real estate companies are feared to have defaulted on their debt repayments and redemptions!


Fixed Maturity Plan (FMP) versus bank Fixed Deposit (FD)

Please come back to read “A comparison between bank FD and FMP: FD versus FMP”.

Income Tax (IT) treatment of returns from Fixed Maturity Plans

FMPs are debt mutual fund schemes. So, they enjoy all the income tax benefits that other debt funds of MFs enjoy.

Dividend Received

The dividend that you receive from an FMP is tax-free.

Short Term Capital Gain

Any short term capital gain from FMPs is added to you income for that year, and is taxed as per the applicable income tax brackets / slabs.

(Want to know the current IT slabs? Please read “Budget 2008 – Impact of Income Tax Slab / Bracket Changes on You”)

(Want to know the classification of gains as long term and short term? Please read “Long Term and Short Term Capital Gain – Income Tax Calculation”)

Long Term Capital Gain

Any long term capital gain (a gain from an investment made for at least a year) is taxed at a special rate – 10% without the benefit of indexation, or 20% with the benefit of indexation.

(To know the cost inflation index – CII – for various years, please read “Long Term Capital Gains (LTCG) on Sale of a House – Calculation and Income Tax”)

Other articles you might be interested in:

Related Articles:

  • No Related Articles.

Comments via Facebook

Facebook comments

Read previous post:
Banks in India start cutting lending and deposit rates

Indian banks, mostly public sector undertakings (PSUs) have started lowering the interest rates following the change in the overall interest...

Close