Followers of my blog will know that I have significant investments in Fixed Maturity Plans of fund houses. These were undoubtedly the best instruments till 2014 where the LTCG indexation was available after 1 year as opposed to 3 years for other debt funds. In that period all capital gains from FMP were akin to tax free income for me
While the Finance minister changed the LTCG time frame to 3 years in the budget of 2014, FMP was still a viable instrument if you were willing to hold it for 3 years. The reasonable returns, coupled with the indexation benefits made it more attractive than many other Debt funds. Personally, I rolled over all my FMP investments to 3 years and that worked quite well for me – I used the capital gains for my regular expenses, mostly discretionary ones, and reinvested the principal amount in FMP or other hybrid funds. Of late I have preferred Hybrid funds rather than pure Debt focused FMP.
So why do I say now that this is no longer something which can pay off? There are two broad trends in this space that forms the basis of my opinion. Firstly, with the lowering of inflation and consequently the interest rates any fresh FMP will be likely to give returns only between 7 % and 7.5 %. Remember that by it’s very nature FMP’s invest in securities at the start of term and hold it till maturity. While this provides good downside protection, it obviously does not work well when the interest rate cycle reverses direction. For example even if the interest rates increase by 100 basis points next year, the 3 year FMP I start now will not get any benefit from the same.
Secondly, with the inflation rates in the economy having a downward trend, the Cost Inflation Index is rising at a much slower pace than before. As a result the indexation benefits one was used to getting earlier will be significantly lower now. In real terms this means higher capital gains after indexation and therefore a higher tax liability. These two factors combined will mean that your effective post tax returns from FMP will be much lower than it used to be 2 years back.
Let me try to illustrate this with a real life example from my portfolio below:-
- An ICICI FMP bought in November 2013 and rolled over subsequently has now matured in July 2017.
- Purchase cost was 1 lac, Redemption was done at 1, 34, 529 Rs and the indexed purchase cost with application of new CII was 1, 19, 809 Rs.
- Capital gains after indexation is therefore 14, 720 Rs. Tax on it @ 20 % is 2944 Rs.
- Effective returns over 3.5 years is therefore 31.5 %
- CAGR over this period will be only 8 %
Now while a post tax return of nearly 8 % is definitely not bad in today’s scenario, remember that this will keep getting worse and will be a lot lower for an FMP you are entering today for the next 3 years.
Now if we agree that FMP is not the preferred instrument of investment right now, the question remains as to where can we invest then? I will recommend Hybrid funds that have some exposure to equity apart from debt. Look at the following options:-
- Dual Advantage Funds among FMP space
- Equity Savings Funds
- Monthly Income Plans
- Dynamic Funds
All these will come with some risk exposure but 3 years on our markets should be doing better than today anyway.