Fixed Maturity Plan vs. Fixed Deposit- Which One is Better?

Fixed Maturity Plan or Fixed Deposit? On one hand we have a traditionally prevalent method of earning returns from money and on the other we have a modern method of investing, which offers a relatively higher net return. Did you know that the major difference between these two financial instruments is the post-tax returns?

Read on to find out more about the difference between these two financial instruments, which have fixed tenures, are easy to manage but are strikingly different from each other.

What is an FD?

Fixed Deposit or FD is one of the most popular ways of saving in India. FDs are safe, easy to open and offer good returns to the investor. Fixed Deposits are generally preferred over the ordinary savings account since FD accounts offer a higher interest rate.

Things to Remember before Investing in FDs

• All banks do not have the same minimum deposit limit for FDs. While SBI has a very low minimum deposit limit of Rs.1000, many private banks have a higher minimum deposit limit.

• The interest payout frequency isn't fixed. Even though the interest earned on an FD is generally paid out along with the principal amount, you can change the frequency of interest payouts to quarterly, annually or even monthly!

• It is important to know the compounding frequency of the FD. Banks generally compound the interest on a quarterly basis. However, if the quarterly frequency is daily or monthly, the interest earned on the FD will be higher.

• Senior citizens can earn an additional interest rate of 0.25%-0.75%

• The investor will be required to pay a nominal penalty for premature withdrawal of a fixed deposit.

What is an FMP?

FMP or Fixed Maturity Plan is a debt-based scheme, and it has a fixed tenure. It terminates on a predetermined date, and FMPs are considered an excellent alternative for the investors who wish to park their funds for a specific period of time and earn relatively higher returns.

Recently, FMPs in India have increased in popularity due to the low level of risk involved. The investor can easily predict the returns from an FMP. The rate of return on FMP depends on the prevailing rate in the money market, which right now, is quite high!

Things to Remember before investing in FMPs

• According to the norms of the market regulator, FMPs cannot provide assured returns. FMPs can only indicate the returns on the investment.

• You must look for the investment objective of the scheme, investment strategy and the indicated yield.

• FMPs invest in commercial papers, high-rated securities, certificates of securities, money market instruments, etc.

• Since FMPs are held until maturity, the investors cannot exit before the date of maturity, which poses as a problem for liquidity. FMPs offer low levels of liquidity.

• FMPs can be traded only in stock exchange where they are listed. However, trading of FMPs is difficult in India since the secondary market is not yet developed

The Difference

Mutual fund advisors suggest that FMPs are a great investment for investors who opt for an FD otherwise, since the returns on FMPs have improved over the last few months. Let's list out some basic differences between FMPs and FDs to understand this rift better.

Risk of capital loss

FDs are known to offer negligible risk to the investors since the interest applicable on an FD is predetermined - depending on the amount that you have invested, you already know the interest that you'll be earning on the investment.

However, you might incur substantial capital loss by investing in FDs. Depending on the monetary policy devised by the RBI and economic environment, the banks tend to tweak their deposit rates to maintain a healthy profit margin.

For instance, the bank might offer an 8% interest rate two months after you have invested in an FD which incurs an interest rate of 6%. You end up effectively losing returns on that FD since you lost a higher earning opportunity.

For risk-averse investors, FMPs assure a low risk of capital loss compared to equity funds because the funds are invested in debt instruments (such as bonds, debentures, mortgages, etc) and the securities are held till maturity. Since FMPs are debt products, they have a negligible risk concerning interest rate as the schemes invest broadly in assets which mature on or before the maturity of the scheme.

Liquidity

If you're looking for liquidity, then you should invest in the bank FDs. If there is an emergency, then bank FDs can be easily liquidated by paying the penalty amount for premature withdrawal, but the investor cannot liquidate the FMPs since the funds are close-ended and they can only be withdrawn when the scheme matures.

Tax efficiency

FMPs offer greater post-tax returns than bank FDs, particularly for those in the highest (30%) tax bracket. These funds grant indexation benefits, which help in lowering the capital gains and thus tax outgo is also lowered. Comparatively, if you're in the 30 per cent tax slab, a 7 per cent FD may be providing you only 4.9% net returns, which is further diminished if you take the rising inflation into account.

If you have no obligation to liquidate the investments and fall in the 30% tax bracket, then the three-year FMP will suit your financial needs the best!

Why is Investing in FMPs a Better Option?

With the increase in the 10-year-old Government Securities yields over the last year, there has been a dynamic shift in the opinion of the investment analysts concerning investment in FMPs. However, it cannot be said that FMP is an absolutely risk-free instrument as it has credit risk, i.e, if the rating of any of the underlying securities is affected, the returns from an FMP could also get affected.

Analysts say that investors must exploit the current high-interest rate environment to invest in the FMPs for at least three years till the rates start coming down. FMPs are perfect for earning high risk-adjusted returns post-retirement.