FMP's or FD's... What are you opting for!!!

In the recent past, many negative events have unfolded which has kept the Indian equity markets volatile. The devastating Tsunami in Japan and the political unrest in MENA nations (Middle East & North Africa) has led to a rise in the international prices especially crude oil which in turn has restricted the domestic inflation to cool down. Inflation rate as on March, 2011 has been recorded at 8.98%, higher than RBI's expectation of 8% by March end.

As a measure to cool down the inflation, RBI has increased the key rates (Repo & Reverse Repo rate) eight times since March, 2010 and is expected to do the same in its monetary review on 3^rd

 May as well.

This increase in the key rates has enforced the banks to increase their Fixed Deposit rates across various tenures. The volatility in the equity markets has also left the investors apprehensive on the future outlook and hence they have started parking their excess funds in Bank FD's at the so called attractive rates.

But, are Bank FD rates really attractive even at this stage.

My answer would be NO simply because at face value we might earn 10% p.a. return for a 1 year FD, however a post tax return would give a yield of 7% p.a. (assuming highest tax bracket) which does not even beat the inflation in today's terms.

In such a scenario, FMP's or Fixed Maturity Plans can act as a substitute to Bank FD's.

Comparison between FD’s and FMP’s

Instrument	FD's	FMP's
Offerings	Offered by Banks	Offered by Mutual Funds
Tenure	Pre Defined	Pre Defined
Return	Assured return	Estimated return
Portfolio	Used for lending	Proceeds invested in Debt Papers
Taxation	Taxed at marginal rate	As per indexation*

*Indexation – accounting for increase in cost of living due to inflation

FMP's are debt instruments offered by Mutual Funds which usually invest in debt papers like Certificate of Deposits, Corporate Fixed Deposits, Commercial Papers & other Money Market instruments. Since most of the FMP's are traded on the exchange, it also gives an exit route to the investors (with some exit load).

FMP’s are more preferable than the Bank FD’s as they offer higher post tax return and this is proved from the below example.

Particulars	FMP (with indexation)	FD
Investment Month	Feb, 2011	Feb,2011
Amount invested	100000	100000
Assumed rate of return / interest (pa)	10%	10%
Tenure of investment (days)	365	365
CII-Year of investment (2010-2011)	711	-
CII-Year of maturity (2011-2012) **	760	-
Indexed cost	106891.70	-
Value at maturity	110000	110000
Interest income	10000	10000
Capital gain / loss adjusted for indexation	3108	-
Applicable tax rate	22.66%	33.99%
Long-term capital gains tax liability	704	3399
Net gain	9296	6601
Post-tax returns at maturity (pa)	9.30%	6.60%

(**CII – cost inflation index for 2011-2012 is assumed to grow @7%. Every year it is declared by CBDT)

The above clearly indicates that even though both the products offer similar pre tax return, FMP’s due to the indexation benefit offer a higher post tax return.

All said & done, nothing comes for free. As FMP’s offer higher return, the risk component is also marginally higher than Bank FD’s. This is due to the interest rate risk and quality of papers they invest in.

But now a days the mutual funds floating the schemes have to follow stringent guidelines laid by the regulator, hence the investors that normally come under the 20% and 30% tax bracket can opt for Fixed Maturity plans and be one step closer in achieving their Financial Goals.

Happy Investing!!!

Disclaimer: The data and information provided in this article is only for informational purpose. This being a personal web log, the opinions expressed here represent my own and not those of my employer.