FINANCE TIP OF THE DAY
Can you afford your loan?!
Know the quantity of loan you can afford. The banks may sanction loan based on your income but you should look at your monthly expenditure and see if you can afford the maximum that banks offer. As a thumb rule, remember not to let your credit exceed 40% of your income!
Understanding Fixed Maturity Plans
The markets have remained volatile over the past few months and there are no indications of a steady environment in the near future. Under these circumstances more and more people are opting to invest in safer avenues such as bank fixed deposits. In order to get a share of the money going into the FDs, mutual funs houses have come up with this unique concept of FMP which is can be considered as the mutual fund equivalent of bank FDs. The primary targets of these FMPs are conservative investors who look for safe and secure returns.
What are FMPs?
This is a relatively new concept as an instrument of investment about which the awareness is restricted. These primarily debt mutual funds which are close ended and have typical maturity periods of one to five years. These plans are created by fund managers who purchase debt instruments that are oriented with the maturity period of the plans. By this method the investment is kept secured while market expectations are also met simultaneously.
Key Benefits of FMPs
There are several benefits of the FMPs which make them a lucrative option available in the market. The most important advantage of the FMPs is that for tax purpose they are treated at par with fixed deposits. Since they are basically debt funds they also enjoy all the benefits of the debt funds in terms of short terms capital gains as well as long term capital gains. For the short term capital gains, the income from FMDs as in the case of any debt oriented fund is added to the annual income and the taxation is done as income tax. In case of the long term capital gains, the income from FMPs, as in the case of all debt oriented funds, is taxed as the higher among the two – 10% without indexation and 20 per cent with indexation.
Comparing the FMPs with Bank Fixed Deposits
In order to understand the basic advantages of investing in fixed maturity plans as against conventional bank fixed deposits we will have to compare the returns from both these instruments both pre tax as well as post tax. Assuming an initial investment of Rs. 10000/-, let us study the variations in returns in different options.
|Instrument||Bank Fixed Deposit||FMP (Dividend)||FMP (Growth < 1 year)||FMP (Growth > 1 year non indexed)||FMP (Growth > 1 year indexed)|
|Pre Tax returns||Rs.1000||Rs.1000||Rs.1000||Rs.1000||Rs.1000|
|Indexed Pre Tax returns||Rs.1000||Rs.1000||Rs.1000||Rs.1000||Rs.1000|
|Net Returns||Rs.670||Rs.857.60||Rs. 670||Rs.900||Rs.912.52|
In this table the various tax implications in different schemes of FMPs as compared to the tax implication in a bank fixed deposit is illustrated on an initial investment of Rs. 10000/- with a interest rate of 10%. Important derivations from the above table of comparison are as follows:
- The net returns from FMPs far exceed that by any bank fixed deposit.
- The dividend option is better when buying FMPs for less than a year.
- The growth option is better when buying FMP for more than a year.
- Maximum double indexation benefit can be achieved by buying a FMP towards the very end of a financial year which is eligible for redemption at the commencement of a future financial year.
Area of Concern in FMPs
While the FMPs may appear to be the ultimate investment option when seeing the above the table, there are a few shortcomings that one needs to be aware of when investing in FMPs. There are a few assumptions in the above discussed table which require a closer look.
- Firstly the above table assumes that the return from the FMPs and the bank FD is same. However this may not be true always. The actual return from a FMP is not secure or guaranteed.
- Secondly the FMPs may invest in commercial papers of a variety of businesses. Thus an over ambitious FMP may make aggressive investment in businesses that have lower CRISIL/ ICRA ratings thereby exposing the investment to risks.