Fixed Maturity Plans or Fixed Deposits: which is better?

When it comes to investments, fixed deposits have been the most popular choice among us Indians. However, with inflation hovering around 6%-7% in recent years, FD returns of 8%-8.5% p.a. barely overtake inflation post-tax adjustment.

So, have you explored other investment instruments that deliver better returns than FDs? In this article, we will be looking at one such example — the fixed maturity plans (FMPs) offered by the fund houses. These plans deliver returns of 10%-11% p.a., easily surpassing inflation levels and letting you save some for a rainy day. They are close-ended products that invest in certificates of deposits, commercial papers, money market instruments, corporate bonds or even bank fixed deposits and vary across various maturities.

Returns aside, let’s see how the two products stack up against each other on various parameters.

Capital Safety

In this aspect, fixed deposits score over FMPs. Both the principal as well as the interest amount are completely safe in a fixed deposit. FMPs have been modified by the Securities and Exchange Board of India (SEBI) over time to make them safer for investing but they do carry credit risk and interest rate risk. Credit risk is the risk of default that may arise if the company’s debt in which the fund has invested fails to pay back.  For example, if the company deposit in which the FMP has invested defaults then the returns of the FMP will be impacted. The interest rate risk is taken care of to a large extent as the FMP invests in debt papers having the same maturity as that of FMP. Thus, the fluctuation in the price of the debt paper before maturity doesn’t affect the final returns.

Liquidity

Fixed deposits are highly liquid. You can withdraw money from a fixed deposit before the term is over by paying a premature withdrawal penalty of about 1%. But, you cannot redeem FMPs before the maturity date. The only exit route available in the case of FMP before maturity is through the stock exchange but it might be difficult to sell the fund on the exchange as trading volumes are usually low.

Returns on investment

Returns from bank deposits are fixed at the time of investment; therefore you know exactly what you will get at the end of the tenure. Use our FD Calculator to calculate the maturity amount of your fixed deposit. In the case of FMPs, the returns are not fixed. The investor can gauge the returns from the credit quality and maturity of the debt papers the fund will be investing but the actual returns may be different from the indicative returns.

The following table shows how much top-performing FMPs have delivered over a 1-year period

FMPs	1- Year return (%)
HDFC Fixed Maturity Plans – 1127 Days – March 2014 (1) – Regular Plan	12.16
HDFC FMP 1175D Jan 2014 (1) Reg	11.85
HDFC FMP 793D Feb 2014 (1) Reg	11.73
ICICI Prudential Fixed Maturity Plan – Series 75 – 1100 Days – Plan G – Regular Plan	11.56
ICICI Prudential Interval V Monthly Interval A Reg	11.12

As on 18^th September 2015

Taxation

In the case of fixed deposits, the interest earned is added to your income and taxed as per your tax slab. In the short term (less than 3 years), FMPs are taxed the same as fixed deposits, that is as per the slab while long-term gains (after 3 years) are taxed at the rate of 20% after adjusting for inflation.

So, for long-term investments, the tax incidence will be lower in the case of FMP due to the indexation of gains. Check out the following table to know how you save on tax by investing in FMP for the long term.

Tax calculation

		Fixed deposit	FMP
1	Amount invested  (Rs)	1,000,000	1,000,000
2	Tenure (years)	4	4
3	Rate of Return (%)	8	11
4	Maturity value (Rs)	1,372,785	1,543,509
5	Interest earned (Rs)	372,785	543,509
6	Indexation benefit (Rs)*	Nil	304,459
7	Taxable gains (Rs) (5-6)	372,785	239,050
8	Tax to be paid @ rate of 30% (Rs)#	111,836	71,715
9	Final gains (Rs)	2,60,949	1,67,335

*Assuming the amount was invested in FY 2011-12, # assuming the investor falls in the highest tax bracket

Ease of investment

You can invest in a fixed deposit on any working day. In fact, you can create a fixed deposit in a few minutes using your net banking account. In the case of FMP, you can only invest during the new fund offer period as these are closed-end mutual funds.

Also, fixed deposit of all tenures is available all the time but FMPs of all maturity periods may not be available at all the time. Currently, all the FMPs available in the market have a maturity period of over 3 years.

Where to Invest: Fixed Deposit or FMPs?

From the above discussion, it is clear that fixed deposits are for people who don’t want any element of uncertainties with their investments while FMPs provide better returns with a little bit of risk. So, choose the product that matches your investment profile.

Comparison of FMPs and Fixed deposits

Basis	Fixed Deposit	FMP
Tenure	7 days  to 10 years	1 month to 5 years
Liquidity	Possible before tenure is over after paying premature withdrawal fees	Can’t be redeemed before maturity. Investors can sell on a stock exchange in case he finds a buyer.
Return	Are guaranteed and will depend on the tenure of the deposit	Not guaranteed, will depend on the returns from the underlying securities
Taxation	Will be added to the income and taxed as per the tax slab	Short-term capital gains will be added to the income tax as per the tax slab Long-term capital gains tax will be taxed at the rate of 20% post indexation