In order to attain your financial goals, it is important that one considers the wider macro-economic and micro-economic factors affecting investments and also widens the scope beyond traditional avenues such as bank fixed deposits (FDs). Investors with a low risk appetite may consider Fixed Maturity Plans (FMPs), a category of debt mutual funds that offer several benefits.
What are FMPs?
Fixed Maturty Plans are closed-ended schemes of mutual funds, with maturity periods ranging from 1 month to five years, that invest in debt instruments such as T-Bills, Certificate of deposits and Commercial papers.
The tenure or maturity of these instruments matches that of the fund itself, thus lowering the interest rate risk of the portfolio and making it attractive. Thus, returns on FMPs get locked-in as all investments are held till maturity while at the same time providing capital protection from interest rate volatility.
Unlike equity funds, FMPs carry much less risk of loss of capital from market volatility. Since the instruments are held till maturity, these funds also have lower expense ratio as compared to other debt funds.
FMPs score over FDs
Main advantage of FMPs versus Fixed Deposits is that they offer indexation benefits. Indexation helps lower capital gains, thus lowering capital gains tax. This is, however, applicable in FMPs with maturity of more than three years, as they are considered long term and inflation indexing can be done for the said period. FMPs also offer double indexation benefit, which further helps reduce taxability of returns.
FMPs especially score over FDs for those investors who fall in the higher slabs of income tax bracket and are subjected to witnessing a significant portion of their FD interest get lost to taxation.
FMPs provide better risk-adjusted returns than most bank fixed deposits. Further, with interest rates on their way up, longer-term debt funds are subject to more volatility as compared to FMPs since these fixed horizon funds invest generally only in AAA-rated debt instruments and hold them to maturity.
Who should invest in FMPs?
FMPs are most suitable for the low-risk-low-return category of investors. While they do not ensure fixed rate of interest, they do offer better post-tax returns as compared to bank fixed deposits.
For investors in the higher tax brackets, FMPs offer a more suitable alternative. Further, since the benefit of indexation is applicable only on funds with over 3 years’ maturity, those investors who do not have liquidity requirement for the next three years can consider FMPs.
Thus, in times of rising interest rates, when debt funds become volatile, FMPs are a more secure alternative to bank fixed deposits, especially for investors in higher income tax brackets with low liquidity needs.