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While markets are at a mess, FMPs offer a great solution to investors not only for returns but also for saving taxes
Skepticism is one word which amicably describes the investors’ investment plans with regard to equity or equity related funds. Cautious investors are readily looking to bring down the risk percentage in their portfolio and as stocks continue to be amongst the most hated lot, debt investment avenues such as Fixed Maturity Plans (FMPs) which combines small investment, tax savings and assured returns seem all the more appealing. FMPs as the name suggests, come with a fixed maturity period ranging from 3 months to 3 years. These are debt schemes, where the corpus is invested in fixed-income securities. FMP helps in the mitigation of interest rate risk as they invest in instruments held till maturity and maintain the portfolio return throughout the tenure of the fund. It carries minimal liquidity risk as it is designed to encourage investors to remain invested till the maturity of the scheme. Of late it has been giving good competition to fixed deposits (FDs), PPF and NSC. It is no wonder that with an indicative yield of 10.6 – 11.75%, FMPs moped up a whopping Rs.440 billion of investor wealth in 2008 alone.
Lower tax incidence and assured returns are the key to the success of FMP. In the case of fixed deposits, the interest earned is added to the investor’s income, which is taxable at the rate applicable to the investor’s tax bracket (which means an outgo of 33% of tax for deposit holders in the highest tax bracket). However, with FMP, the investor can choose to treat the interest/gain from the FMP as capital appreciation, which has a lower rate of tax (about 10% without cost indexation and 20% with it). This is especially beneficial for FMPs with tenure for more than a year. Longer tenure FMPs can avail the double indexation benefits while FMPs with a duration of less than one year can benefit if the investor cashes the gain as dividends. This way the investor is taxed at just 12.5% of the returns. This is one of the primary reasons why this scheme is beneficial for investors in high tax bracket.
Meanwhile, with fund houses launching this product with a minimum investment of Rs.5,000 it is becoming a favourite among small investors as well. As far as assured returns are concerned the time horizon needs to be considered; an investor with one month horizon should opt for liquid funds while those with say 3-9 month time frame can opt for FMPs. However, a word of caution from K. Sitaram, Head of Crisil Fund Services, “Fund houses use higher indicative yields as a marketing gimmick but they end up investing in low-grade paper.”
With the stock market and mutual funds yielding very little to zero returns FMPs are offering a breath of fresh air. Risk - averse investors, especially those falling into the higher tax bracket should opt for FMPs as their portfolios do not change much.
Gyanendra Kumar Kashyap
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Source : IIPM Editorial, 2009
An Initiative of IIPM, Malay Chaudhuri and Arindam chaudhuri (Renowned Management Guru and Economist).
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