FMP - AN ALTERNATE TO BANK FDS

Fixed Maturity Plan (FMP) is a type of Mutual fund that invests in financial instruments such as bonds issued by Govt and Corporates and money market instruments like certificates of deposits , treasury bills and commercial papers for a fixed period of time. FMP's are generally run by Fund Houses for a period varying 15 days , 30 days , 90(91 )days , 180(181 )days ,365( 367) days etc .

Basically they are a close ended scheme but have an exit option wherein an exit load is levied. The expected return is generally indicated at the time of investment but the returns might not be on expected lines.

As compared to Bank FDs the tax benefit is in the form of Double indexation, The taxable amount is calculated using the following formula:

Taxable Gains = Amount Returned * (Amount Invested * Inflation Index for Redemption Year/ Inflation Index for Investment Year)

The following example explains this concept:

Suppose a plan returns 4% on an amount of Rs 10,000, invested for a period slightly greater than a year. Thus the amount returned would be Rs 10,400. Now suppose, the inflation index calculated for the period is 1.05. This means that an amount of Rs 10,500 (10,000 multiplied by 1.05) would be used for calculating taxable gains.Since Rs 10,400 is less than this amount, there is no gain on which tax is applicable. However, suppose the return from the fund amounts to Rs 11,000. Then, the investor has to pay taxes on a gain of Rs 500, even though the net gain was Rs 1,000.

Advisory

Investing in FMPs for a tenure of 1 year could be a risk subject to change in tax policy changes that might occur.If the finance minister restructures the tax policy to discontinue double indexation, then investors might have to pay more taxes on gains from FMPs. In this case, they won't be of help to medium-term and long-term investors.

So far as short-term plans are concerned, bank deposits might prove out to be more remunerative at times. Thus, an in-depth analysis is required before investing in FMPs of maturity less than 1 year.

For FMPs less than a year the dividend option is usually a better option.

FMPs are not aggressively sold by brokers as the brokerage involved is low so one has to be after them to get to know about FMP's offered by fund houses.All NAV's (Net Asset Value) are displayed by the Fund House the same night or next morning

Caution

The Finance Minister has asked for data related to the investment made by Funds Houses as regards the portfolio of FMP. It seems that most fund houses have invested in Realty Companies papers which are known for defaulting which makes FMPs a risky proposition.

The investor must have a look at the portfolio of the previous FMPS offered by the Mutual Fund Houses.

An illustration:

UTI Mutual Funds started an FMP for 91 days SERES I-II on 15 July 2008 NAV 10 Rs and maturied on 14 Oct the NAV being 10.2604 Rs. So the expected return was approximately 10.416% which is quite decent as no bank FD would give you a return on 10.4% for 91 days during the period of July to Oct.