Asset allocation and portfolio rebalancing play an important role in investment decisions in the current volatile market.
Though the key investment avenues are equity, debt, commodities and real estate, debt is considered the safest of all.
Among various debt products being offered by banks and other institutions, bank fixed deposits have great recall value. The other viable instrument in debt is fixed maturity plan or FMP.
Under fixed maturity plan, one needs to invests in funds for a fixed period such as 90 days, 181 days, 370 days or even 1,000 days.
FMPs invest in instruments that mature at the same time their schemes come to an end. So a 90-day FMP will invest in instruments that mature within this period. This ensures that the schemes are saved from the volatility in the interest rates.
Though returns are not guaranteed in FMPs, one can have a fair idea of the expected return on the basis of indicative returns, which are based on the quality of papers invested.
Advantages
* The returns attract capital gains tax, with indexation benefits for the long term return.
* It has lower interest rate volatility.
Disadvantages
* It fares low in terms of liquidity as the instruments are to be held till maturity, except if one has a demat account, wherein one could sell at the time of emergency fund requirement.
* As returns depends on the quality of papers held by asset management company, similar FMPs of different AMCs could give a different return based on the quality of papers in the portfolio. A risky portfolio will get you a higher return, but it could be subject to default in redemption as it happened in late 2008.
We strongly advocate having some portion of the funds in bank fixed deposits to meet the emergency ne-eds. The rest can be channelised in more effective in-struments such as an FMP.
Comparision
* The main advantage of FMP over bank fixed deposit is the tax arbitrage. The interest on fixed deposit is taxed at 30 per cent, if one falls in the said tax bracket. However, in case of a FMP in excess of one year duration, the returns are taxed at 10 per cent without indexation and 20 per cent with indexation. For a shorter term duration, on dividend option, the dividend distribution tax is 14.22 per cent for individuals.
On a 7.5 per cent return, for one-year plus plan, the return from an FMP, without indexation is greater than 1.5 per cent, as compared to a fixed deposit (see graphic above).
Conclusion
As it is apparent from the tax benefits, one could invest a portion of the debt fund investments into fixed maturity plan. However, you do have to understand that FMP fares low in liquidity and only those funds which are not required, as per the Time Horizon should be invested into the FMPs.
Brijesh Damodaran
Founder – WealthWays Private Wealth Management and can be contacted at brijesh@wealthways.in [1]
Links:
[1] mailto:brijesh@wealthways.in