My Debt portfolio – rethinking FMP

Readers who have read my earlier blogs will have a good idea about my 3 portfolio strategy and how I use it for generating passive income as well as growth for the future. A major part of my Debt portfolio is FMP schemes and I have been investing in these for the past few years to build up a decent portfolio.

In essence the FMP strategy was quite simple to start with, especially when the LTCG indexation benefits were available after 1 year. Between 2008 and 2013 the cost inflation index was increasing by more than 9 % or so every year. This meant that you could practically get tax free returns of 8 % or slightly more every year. All you had to do was reinvest the principal amount in another FMP scheme and use the capital gain for whatever purpose you wanted. When I was looking at setting up a passive income stream from 2015, this seemed like an ideal avenue. I reasoned, if I could have about 50 lacs in different FMP schemes and roll them over every year then my capital gains would be about 4 lacs assuming an return rate of 8 %. Along with some other passive income elements, this would go a long way to meeting the 8 lacs of current annual expenses that I have.

However, in the personal finance space any plan is good only in the current context and a change in the environment will necessarily mean you have to change your plans. The first spanner in the works were thrown by Arun Jaitley after BJP came to power. He made all Debt funds, including FMP, eligible for LTCG only after 3 years. This immediately meant that my plan of rolling over the FMP schemes yearly, was a non starter. Fortunately, some of the schemes I had invested in were already 3 years and for the rest a rollover was made possible by all the fund houses. As I was able to direct some of my active income towards my expenditure needs in 2015, the 3 year time frame did not really affect me. From 2016, I roughly have 20 lacs worth of FMP investment maturing every year. This will yield roughly 4.8 lacs in Capital gains as the holding period is at least 3 years for all maturing schemes. So in theory my earlier plan or reinvesting would still work, though with a 3 year duration as opposed to the 1 year duration I had thought of earlier. Note that I prefer FMP as the interest rates are locked in to a significant extent and are not prone to risks as other types of debt MF schemes are. For my debt portfolio, stability and regularity of returns is key.

Though the above strategy looked great, I am now having to rethink it as there is another significant change that has happened in our environment. With the inflation rates coming down, the cost inflation index will obviously increase at a lower rate as compared to before. In the last year the increase has been less than 6 % and going forward I do not expect it to be very different, a lower rate of increase is actually likely. This will mean that even after indexation, there will be some capital gains tax which needs to be paid. This is a double whammy for FMP schemes – the returns will get lower with declining interest rates and the effective taxation will come into play. The returns therefore seen unexciting now.

Now in 2016 I will have about 20 lacs of FMP maturing and I need to reinvest it somewhere. There are a few options that I have thought of. Pure debt funds will suffer from the same issues as FMP and they are likely to have higher credit risk too. Moreover the 3 year locking period with lower indexation benefits, suddenly make these funds rather unattractive. Even though I have never been a fan of mixing equity and debt, as they are very different asset classes, this may be a situation where such a course of action is pragmatic. The following options can be looked at:-

  • A conservative Balanced fund where the risks are contained.
  • An Equity savings fund with both hedged and non-hedged equity in addition to debt.
  • An arbitrage fund with mainly hedged equity.

The good thing about all of these is that LTCG becomes effective post 1 year. The risk is that if the markets do badly the returns from such funds can well be lower than the ones I am getting from my current FMP schemes. However, given the current situation, these seem to be a good idea as the credit risk is limited and potential of returns optimistic if the markets do well in the next 2-3 years.

Of course, once the interest rate cycle reverses the situation will become quite different and a return to FMP type of schemes may well be the order of the day.