Fixed deposits:
Better than savings account are the other investment options like bank fixed deposits schemes. One can invest in a FD with varying maturities. If you need certain amount of money after 1 year, you can invest in for 1 year FD for that much amount and for other amount can have FDs of different maturity.
This will help you meet the liquidity needs and also earn interest. You can go for the regular returns options like the quarterly or half-yearly payout options. Else, you can choose interest re-investment option.
However, remember that interest income earned in FD and savings account is taxable.
FMPs:
Fixed Maturity Plans (FMPs) are income/debt schemes giving a fixed return over a period of time. They are actually similar to fixed deposits in banks. The maturities offered were varied, going from one month to three years. They are close ended schemes, which are open only for a fixed period of time during the initial offer. While the money is locked, FMPs give the investor an option to exit, which is subject to an exit load as per the funds regulations.
While similar to FDs, there are certain differences. While the returns on FDs are assured, returns on FMPs are indicative as there is a possibility of the actual returns deviating from what has been indicated to investors at the time of investing. The instruments are held till maturity, thus not getting affected any interest rate fluctuations.
The schemes have low credit risk as investments are mainly done in AAA or P1+ rated instruments with a short-term maturity profile. Further, it has minimal liquidity risk as they invest in short-term instruments, which give them adequate liquidity. Also the churning cost is very low as the instruments are held till maturity.
Taxation of FMP depends on the investment option. In the dividend option, investors have to bear the Dividend Distribution Tax. In growth option, returns earned are treated as capital gains- i.e. if investments are held for less than a year, than the interest income is added to the investor's income and is taxed at the marginal rate of tax.
As for long-term capital gains, the tax liability is computed using two methods i.e. without indexation (charged at 10% plus surcharge) and with indexation (charged at 20% plus surcharge) and). The tax liability will be the lower of the two.
However, on the flip side, there are no fixed returns in FMP's. It can be lower than what was indicated earlier. Further, here is usually some penalty for early liquidation (before maturity) that can lower or even erode your capital. And one cannot invest anytime in FMPs as they are not available anytime you want them.
MIPs:
Monthly Income Plans (MIPs) are hybrid instruments that invest some portion (around 5 %-20 %) in equities and the balance in debt and money market instruments.
It provides monthly income to investors depending upon monthly, quarterly, half-yearly and annual options selected by the investors. MIPs aim to provide investors with regular payouts in for of dividends. However, it is not mandatory for the funds to declare dividends and is subject to availability of distributable surplus.
Monthly Income Plans (MIPs) are hybrid instruments that invest some portion (around 5 %-20 %) in equities and the balance in debt and money market instruments.
It provides monthly income to investors depending upon monthly, quarterly, half-yearly and annual options selected by the investors. MIPs aim to provide investors with regular payouts in for of dividends. However, it is not mandatory for the funds to declare dividends and is subject to availability of distributable surplus.
While there is growth option to available in MIP, the return will not be in form of dividend but capital appreciation. Some portion of the funds is invested in equities. This provides impetus to the returns while retaining the safety from the debt investments.
It is like icing on the cake and would generate higher returns than the debt fund, albeit with a little higher risk. MIPs are launched with the objective of giving monthly income to investors. MIP is better for investors who are nearing retirement. MIP's appeal to conservative as well as risk taking investors.
Risk in MIP's:
The debt portion is influenced by the interest rates. When the interest rate falls, the NAV rises as price of bond increases. When interest rate rises, NAV falls. At such times the equity portion of the fund helps to maintain the returns.
While equity portion makers it more risky than the pure debt fund, they are better than the balanced fund where investment in equity is to the extent of 40% to 50%. And with Indian markets expected to do good in the long term, MIPs would stand to gain.
On the tax front, they are better than FDs as dividends are tax free in the hands of investors, while interest on FDs is taxable.
Thus considering one's risk bearing capacity and investment objective, one can decide on either of these three investment avenues.
While equity portion makers it more risky than the pure debt fund, they are better than the balanced fund where investment in equity is to the extent of 40% to 50%. And with Indian markets expected to do good in the long term, MIPs would stand to gain.
On the tax front, they are better than FDs as dividends are tax free in the hands of investors, while interest on FDs is taxable.
Thus considering one's risk bearing capacity and investment objective, one can decide on either of these three investment avenues.
What is better --- A Bank Deposit or a FMP?
Lately the interest rates on bank deposits have increased leading many investors to wonder whether a simple Bank Fixed Deposit would serve better than having to go through the process of investing in an FMP. Though Bank FDs and FMPs currently offer a similar rate of return; the tax impact tilts the scales in favour of the FMP.
Interest on bank FDs is fully taxable whereas the return from FMPs is either subject to the Dividend Distribution Tax (for the dividend option) or the capital gains tax rate (for the growth option).
The Distribution Tax rate @14.16% or the capital gains tax rate @10% are lower than the income tax rate, especially in the case of investors in the higher tax bracket. Tax directly eats into returns, which is why FMPs have the edge over Bank FDs.
Interest on bank FDs is fully taxable whereas the return from FMPs is either subject to the Dividend Distribution Tax (for the dividend option) or the capital gains tax rate (for the growth option).
The Distribution Tax rate @14.16% or the capital gains tax rate @10% are lower than the income tax rate, especially in the case of investors in the higher tax bracket. Tax directly eats into returns, which is why FMPs have the edge over Bank FDs.
To illustrate this point, have a look at the following table. It is assumed that both, the Bank FD as well as the FMP yield the same rate of interest i.e. 10.25% p.a. An investment of Rs. 1 lakh is made in an FMP of 91 days. The corresponding figures for the Bank FD appear alongside.
Source: rediff.com
Today markets are extremely choppy. Depending upon whom you talk to, either a severe correction is round the corner or the market is going to go up by a couple of thousand points more. Though no one has seen what tomorrow will bring, common sense indicates that a post tax yield of almost 9% is too good to ignore.
If you are looking for a fixed income avenue that yields a reasonable return with minimum risk, adequate liquidity and tax efficiency, FMPs will provide you with an effective shelter.
Prepared By:
RISHMA SHETTY
(BUSINESS DEVELOPMENT)
(BUSINESS DEVELOPMENT)
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