Should you invest in FMPs?

n a number of our pieces, we have been referring to Fixed Maturity Plans.

Our readers have been curious to know more about it. So here's to explaining FMPs and whether or not you should be investing in them.

What is an FMP?

Mutual funds offer Fixed Maturity Plans.

Two features make them distinct from other fund schemes: 

1. Tenure

FMPs have a fixed maturity date. It could be 15 days, 30, 90, 141, 180 or even 365 days. Some even have a three or five-year time frame.

Recently, Birla launched such a plan for 18 months and 36 months.

At the end of this period, the scheme matures, just a like a fixed deposit.

2. Investments

FMPs invest in fixed income instruments, like bonds, government securities, money market instruments (very short-term fixed return investments), to name a few.

• What your mutual fund agent will not tell you

How long is the money blocked?

Before the scheme opens, the tenure is made known. You must pick a tenure most suited for you.

Note: FMPs are either open ended (more the exception) or close ended (more the norm).

Open ended funds allow you to enter (buy units) and exit (sell units) any time you want.

Close ended means they remain open for subscription only for a short period of time. They then close and do not accept any fresh deposits. They also do not allow current investors to withdraw. So your money is locked in during that time frame.

If you need the money urgently, you can sell your units. But you will have to pay an exit load (the fee when you sell the units of a fund).

Close ended schemes charge a load between 1% and 2% of the Net Asset Value (price of a unit of a fund) at the time of withdrawal. This is referred to as an exit load and is levied when an investor wants to sell his/her units.

The reason for this steep load is to dissuade investors from exiting before the fund matures. Of course, if you hold on till maturity, you will not have to pay an exit load.

Generally, there are no entry loads for such schemes. This is a fee charged when investors buy the units of a fund.

• Dividend payout, dividend reinvestment or growth schemes?

How do they differ from income funds?

An income fund will invest in the same instruments like an FMP. But an open ended income fund will not have a fixed tenure.

Because the tenure of the scheme is fixed, it makes investing easier for the fund manager. He can invest in instruments that will mature around the same time the scheme matures, in one go.

So a fund manager with an FMP of a five-year maturity, for instance, will invest only in instruments that have a five-year maturity. Similarly, a one-year FMP will invest in one-year maturity investments.

Because of this, he can even give an indicative return (though he cannot assure one) unlike an income fund.

• Top mutual funds in April 2005

How do they differ from fixed deposits?

The similarity first: both have fixed tenures.

The difference: a fixed deposit gives assured returns. You know what you are getting and when.

An FMP will give an indicative, but not assured, return.

You will be expected to invest a minimum of Rs 5,000 in an FMP. Not so in the case of a bank deposit, which can be less.

• The best funds may not be the safest

What is the tax impact?

If you invest in an FMP, the dividend is tax-free in the hands of the individual investor.

If you invest in the growth option of the FMP for less than a year, the gains are added to the investor's income and taxed at the investor's slab rate.

If you invest in the growth option of the FMP for over a year, you pay either 10% capital gains tax without indexation or 20% with indexation.

Indexation is the process by which the inflation is taken into account when computing the tax liability. To understand indexation, read All about capital gain.

What are the returns you can expect?

The mutual fund will have to pay a dividend declaration tax of 14.5%.  After deducting that, returns in the hands of the investor can be higher than a bank deposit.

Let's assume an FMP gives a return of 5.50% for a one-year plan. Against that compare a one-year bank fixed deposit.

• Why you should watch over your mutual fund

Should you consider FMPs?

Sure. If you do not like to take any risks with your savings and your diet consists of fixed return investments, this is one option to consider.

Or if you have some money that you would like to put away for a very short period of time, this is an option for you.

But read the investment objectives of the scheme carefully before you invest. A fund with a long-term horizon like a few years may have a provision to invest a small portion in equity.

For instance, Franklin Templeton had launched a 60-month plan where a cap of 30% of the investments could go into equity. So make sure you know what you are investing in.

The author is Vice President, Derivium Capital & Securities Pvt Ltd.