FMPs V/s FDs: Which is the safest investing option?

Anil Rego Right HorizonsOne of the safest investing options is a toss up between bank fixed deposits or fixed maturity mutual funds (FMP’s). Till recently FMPs were winning the battle due to their tax advantage, but with the new tax rules have created a more level playing field. Each one comes with its own set of advantages and disadvantages, with the final call being based on the individual investing. Let us take a deeper look at each option. Bank Fixed DepositBank fixed deposits have been considered for years as one of the safest options, with investors putting money in at 8 - 10% p.a. and not worrying about capital protection. This may be a good option for elderly people with very low risk appetites who prefer to trust their banker, and are not worried about liquidity. Another aspect of FDs is that, they are not tax efficient. The biggest advantage of the bank FD is its perceived safety, and its better returns over a shorter time frame. Fixed Maturity PlansThese are close ended funds which invest in government bonds, gilt, etc. to ensure capital protection along with capital appreciation. FMPs have a range of maturity periods starting at 90 days and going up to a few years. The investments into these funds are safe since they invest only in highly rated government paper, however unlike FDs they do not guarantee any interest rate, and one has to take into account their past track record, investments made, etc. to estimate the interest that can be earned. FMPs can be good options in a rising interest rate cycle as they can lock in higher rates. FMPs are thinly traded on the stock exchanges, and one can exit through this route if essential. TaxabilityIncomes from both fixed deposits and fixed maturity plans are taxable. FD interest is always taxed as per your tax slab, while short term FMPs (i.e. those with a tenure of less than 3 years) are taxed at your taxable rate, and long term FMPs (i.e. Those over 3 years) are taxed at 20% with indexation (which is the calculation of the returns earned taking into account inflation rates). Essentially, the purchasing price of the FMP is increased to take into account inflation during the holding period, using the government’s cost inflation index. This effectively reduces your capital gains, and hence your tax. One can choose whichever option that has a lower tax outgo.

Due to this change in tax rules, it becomes even more difficult to choose between the two investment avenues, since for anything less than 3 years the returns will be comparable & similar. For investors willing to lock in their capital for a period of over 3 years, FMPs are still an attractive option, but for other investors, this may not be better than FDs as the returns will be similar. Unlike an FD which offers an assured rate of return, the FMP can give only an indicative rate - hence might be riskier in the very short term. In our view, it is important to take into account your financial goals before deciding between the two. Summary:•    FDs carry a fixed interest rate and tenure •    FMPs are mutual funds that invest in highly rated debt instruments, but do not announce any fixed rate of returns, but the tenure is fixed•    Only Long Term FMPs (> 3 Years) have indexation benefits that help reduce the tax outgo