FMPs or FDs - Which one to choose?

We are sure that you as an investor must have come across this dilemma as to what to choose from – a Fixed Maturity Plan (FMP) offered by a mutual fund house, or a Fixed Deposit (FD). Well it’s confusing for an investor because both of them start with the word ‘Fixed’. So, now let us understand what exactly a FMP is and how it is different from a FD.

A Fixed Maturity Plan is a close-ended fund that invests in debt and money market instruments of similar maturity as the stated maturity of the plan. That means a 90 day FMP will invests in debt and money market instruments which mature in 90 days like 3-month Certificate of Deposits (CDs), 3-month Commercial Papers (CPs) etc. An interesting point to be noted here is that unlike a FD where your maturity amount is fixed, in a FMP only the period or time horizon of the fund is fixed. As such a 90-day FMP will cease to exist on maturity.

The distinguishing feature of a FMP is its indicative return unlike a FD where you know the fixed amount receivable at the end of the maturity period of your FD. So a 90-day FMP at a time where 3 month instruments are yielding 8.0% p.a. does not mean that you will get assured returns of 8.0% p.a., but it is just an indicative yield that highlights the return generating potential of the instrument.

You might say then ‘why I should opt for a FMP where the returns are just indicative and not fixed?’

FMPs are not all that bad as they seem. The tax implication on FMPs gives it a leg-up over a FD. The tax implication on FMPs depends on the investment option one chooses – dividend or growth.

In case of dividend option, investors have to bear the Dividend Distribution Tax (DDT) of 13.84%.

Whereas in case of growth option, returns generated are treated as capital gains and taxed accordingly. Thus, in case of short-term capital gains (i.e. if investments are held for less than 365 days); the interest income is added to the investor’s income and is taxed at the marginal rate of tax. And where investments are held for more than 365 days (long-term capital gains) the tax liability is computed using two methods i.e. with indexation (charged at 20% plus surcharge and cess) and without indexation (charged at 10% plus surcharge and cess); the tax liability will be the lower of the two.

375 days FMP or a 375 days FD

Particulars	FMP (with indexation)	FD
Amount invested ()	100,000	100,000
Assumed rate of return / interest (p.a.)	8.25%	8.25%
Tenure of investment (days)	375	375
CII-Year of investment (2009-2010)	632	NA
CII-Year of maturity (2010-2011)	711	NA
Indexed cost ()	112,500	NA
Value at maturity ()	108,476	108,476
Interest income ()	8,476	8,476
Capital gain / loss adjusted for indexation ()	-4,024	Nil
Applicable tax rate	22.66%	33.99%
Long-term capital gains tax liability ()	0	2,881
Net gain ()	8,476	5,595
Post-tax returns at maturity (p.a.)	8.25%	5.45%

(Interest rates and tenure are assumed. Actual rates offered will be different. CII = Cost Inflation Index) (Source: PersonalFN Research)

The above table depicts that if you fall in the highest tax bracket, the post tax returns you enjoy in a FMP (tenure over one year) are far superior from that of a FD (tenure over one year). After claiming the indexation benefit as you have long term capital loss, the post-tax return enjoyed by you in a FMP is entire 8.25% p.a. whereas a similar tenure FD generates just 5.45% p.a.

90 days FMP or 90 days FD

Particulars	FMP (Dividend Option)	FMP (Growth Option)	FD
Amount invested ()	100,000	100,000	100,000
Assumed rate of return / interest (p.a.)	8.25%	8.25%	8.25%
Tenure of investment (days)	90	90	90
Value at maturity ()	102,034	102,034	102,034
Interest income ()	2,034	2,034	2,034
Applicable tax rate / DDT rate	13.84%	33.99%	33.99%
Dividend Distribution Tax	282	-	-
Short-term capital gains tax liability ()	-	691	691
Net gain ()	1,753	1,343	1,343
Post-tax returns at maturity (p.a.)	7.11%	5.45%	5.45%

(Interest rates and tenure are assumed. Actual rates offered will be different. DDT = Dividend Distribution Tax)
(Source: PersonalFN Research)

The above table depicts that if you fall in the highest tax bracket, the post tax returns you enjoy in a FMP - Dividend Option (tenure less than one year) are far superior from that of FMP - Growth Option (tenure less than one year) and FD. The post-tax return enjoyed by you in a FMP - Dividend Option (tenure less than one year) is 7.11% p.a. whereas a similar tenure FD generates just 5.45% p.a.

In a nutshell…

FMPs are superior to FDs in terms of post-tax returns. However, before investing please ensure you have the right risk appetite for a FMP as said earlier there are no assured returns in a FMP unlike a FD. Also in case of bank fixed deposits, the Deposit Insurance and Credit Guarantee Corporation of India (DICGCI) guarantees repayment of  1 lakh in case of default. There is no such guarantee offered in company deposits and the safety of your deposit depends on the financial position of the company.

• In FDs the rate of return is fixed, while in FMPs the period of maturity is fixed
• Returns on FMPs are not guaranteed while FDs offer guaranteed returns. But only bank FDs are guaranteed with repayment of  1 lakh in case of default, while incase of company FDs, the safety depends on the credibility of the company
• If you fall in the highest tax slab and want to invest in a FMP with tenure of over 1 year, then investment in Growth option will help you enjoy high post tax returns
• Similarly if you invest in a FMP with tenure of less than 1 year, then investment in Dividend option will help you enjoy high post tax returns
• ~
• Source: PersonalFN