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Fixed Maturity Plans (FMPs) of Mutual Funds – Benefits of investing

With inflation figures on the rise, the interest rates offered by banks on deposits are also rising.

This may look like a rosy picture for those who derive a major chunk of their income from fixed deposits as banks now offer more interest for the same amount, but what about the fixed deposits made earlier?

 

How to keep pace with the rising interest rates?

Has the interest offered by banks on these deposits also increased? The simple answer is “no” – the interest offered by banks has increased only for the new deposits.

And what if tomorrow, the banks again increase their Interest rates? Would they offer more interest on the FD which you are making today? The answer, again, is ”no”.

With the answer to both the above questions being no, what can you as a retail investor do? You prefer not to invest in the stock market to avoid the hassles of timing the market. But again, in the fixed income products as well, you have to time the market!

The manner and the speed at which the interest rates fluctuate these days, timing the market has become an important criterion for investing in fixed income instruments as well. And just like we have mutual funds (MFs) who employ professionally qualified staff for investing in the stock markets on behalf of the retail investors, in the same manner we have fixed income products who employ professionally qualified staff for investing in fixed income securities.

 

What are Fixed Maturity Plans (FMPs / FMP)?

Fixed Maturity Plans (FMPs) are close ended mutual fund debt schemes that have a predetermined maturity date. They predominantly invest in government securities, corporate debt, commercial papers and money market instruments and aim at generating steady returns over a fixed period. They protect the investors against market fluctuations by investing in securities in line with their maturity periods.

The maturity period of the FMP varies vary from one plan to another. Unlike other debt funds, an investor can opt for maturity period that suits his needs the best. Depending on the tenure of the FMP, the fund manager invests in a combination of the above mentioned instruments of similar maturity. For example, if the FMP is for a year, then the fund manager invests in paper maturing in one year.

FMPs are close-ended in nature which means that once the NFO (New Fund Offer) closes, the scheme cannot accept any further investment.

 

Benefits of investing in Fixed Maturity Plans

 

Professional Management

As the mutual fund employs professionally qualified and skilled employees, the FMPs are able to invest in better fixed income products as compared to retail individuals.

 

Capital Protection

The risk associated with an FMPs is very low as they predominantly invest in AAA and other highly rated securities.

 

Low interest rate sensitivity

As FMPs tend to hold the securities till the maturity, the interest rate risk associated with them is almost nil.

 

Lower Cost

Since the investment is held till maturity, there is a cost saving in respect of buying and selling of instruments. Therefore, their expense ratio is minimal.

 

Income Tax on Income earned from Investing in FMPs

In case of investment in the growth option of an FMP held for less than 1 year, the gains are added to your income and taxed at your applicable income tax slab rate.

In case the FMP is held for more than a year, Long Term Capital Gains (LTCG) tax is applicable. The Investor has the option to choose the capital gains tax with or without indexation benefits. The income tax rates are:

  1. 10% without indexation benefit, or
  2. 20% with indexation benefits

 

Tax Planning Advice

If you fall in the category of 20% / 30% income tax slab rate, opt for dividend option. This is because the dividend is tax free in your hands.

 

Risks associated with Investing in FMPs

Although FMPs have the potential to earn better than FDs, they are also exposed to some risks:

 

Liquidity Risk

An FMP invests in securities on a hold-to-maturity basis – each security is normally held till maturity once bought. Keeping liquidity in mind, SEBI has made it compulsory for FMPs in India to be listed on the Stock Exchanges. Still, FMPs are not very liquid and if you want to exit before maturity, you may have to sell them at a discount. Thus, for maximum benefits, it is highly advisable that an investor stays invested in the FMP till maturity.

 

Credit Risk

Although most FMPs invest in highly rated securities, they may sometimes invest in not so good instruments in order to earn a quick return on investment. As per the SEBI guidelines, mutual funds cannot disclose the quality of instruments where they are investing and the indicative returns. In this case, it is always advisable to check the credentials of the mutual fund houses before investing in any FMP.

 

This article has been authored by CA Karan Batra, who is a finance and tax blogger on www.charteredclub.com

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