FMP Vs Bank FDs

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FMP or FDAre FMPs (fixed maturity plans ) better than bank FDs (fixed deposits) ?

Its really elementary, FMPs probably offer better post tax returns than bank FDs for most classes of investors but could be theoretically riskier

Confused, by the above explanation? Read on, on reasons why FMPs are generally than bank FDs

Whats similar to FMPs and bank FDs?

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

What is different between bank FDs and FMPs?

There are some fundamental differences between bank FDs and Fixed maturity plans (FMPs)

  • 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.
  • FMPs typically offer an “expected” rate of return, while the bank fixed deposits have a fixed rate of return

    For example, if you invest in bank fixed deposit, you know exactly how much interest you will get at the deposit maturity date. Since fixed maturity plans are also close-ended, the mutual funds typically have a pretty good idea of the expected rate of return, since they lock into corporate debt or Govt securities for a fixed duration.

    However, unlike a bank fixed deposit, the rate of return promised by a mutual fund for a FMP is not guaranteed, but is typically close to the targeted return

    FMPs offer better post tax returns than bank fixed deposits (FDs)

    Aha,this is by far, the best feature of FMPs. The tax benefits from investing in a Fixed maturity plan are further enhanced by the lucrative concept of indexation , especially if the FMP is for a period of greater than 1 year. This is because of the FMP taxation benefits

    This demonstrative table offers a good example why FMPs are so much more tax efficient than bank fixed deposits

    FMP Yield
    Tenure of FMP
    Indexation rate (assumed)
    Long term Capital Gains tax rate
    370 days
    The benefit of indexation for a FMP investor
    Amount invested (assumed) (Rs)
    Cash receivable on maturity; total interest @ 9.30% (Rs)
    Indexed cost (Rs)
    Taxable income (Rs)
    Tax payable (Rs)
    Post tax return (assumed)

    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

    FMPs are potentially marginally riskier compared to bank FDs

    Though 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

    In summary, FMPs are better higher yielding investments for investors, but as they always say,watch out for the fine print

    Related :An analysis of FMPs vs equity investments

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