The Most Authentic Guide on Personal Finance and Investments

Words of Wisdom : "A successful man is one who can lay a firm foundation with the bricks others have thrown at him." ~ David Brinkley

Investment option for a ‘risk-averse’ investor

Fixed Deposit with banks is the most common form of investment for the risk-averse investors. The key factors, that make bank FDs as one of the most preferred options, are 
(i) safety
(ii) fixed & assured returns.

However, this safety comes at a huge cost. The post-tax return, especially for an investor in the higher tax bracket, does not even cover the inflation. Therefore, with time the money in a bank FD is actually loosing value.

There is, thus, a need for alternative investment opportunities.

It is important that this option should provide better returns than a bank FD without compromising on the ‘safety of the funds’ and ‘reasonable assurance of the returns’.

Debt-based Fixed Maturity Plans (FMPs), offered by the Mutual Funds, is one such alternative. Let us analyse how best can it meet the desired objectives.

Safety:  The corpus of such plans is invested in ‘AAA’ and ‘AA’ rated debt-instruments. This provides a good safety against credit default, which could be one of the major risk factors affecting the safety of FMPs. The risk profile of such investments is more or less in match with the bank FDs.

Assurance of returns: Apart from the credit risk, the other risk which could affect the returns is the interest rate volatility. This risk is mitigated through investing the corpus in the debt instruments maturing in line with the maturity of the fund. There is, therefore, a reasonable amount of assurance with regards to the returns.

Liquidity : FMPs are available with varying maturities such as monthly, quarterly, half-yearly, annual etc., which match with the bank FDs. Of course, the main disadvantage of an FMP is that it cannot be closed prematurely like a bank FD.  

Thus from the point of view of Safety, Liquidity and Assurance of Returns, Fixed Maturity Plans more or less match the bank FDs.

Now coming to the most important point – the returns. The tax treatment available to the mutual funds is more advantageous vis-à-vis the bank FDs. This makes the post-tax returns of mutual funds better than the bank FDs.

Let us, for simplicity, ignore the dividend option or the indexed cost option. For without-indexation benefit, your tax liability for a 1-year or more FMP is 10%. Whereas those in the higher tax brackets will have to pay 20%/30% tax on bank FDs.

Thus, it can be seen that investment in an FMP gives much higher post-tax returns for persons in the higher tax brackets...without compromising on any other aspect.

Another factor favouring mutual funds is the TDS. Since TDS is not applicable to mutual funds, it becomes a simpler proposition vis-à-vis bank FDs, where many investors have to face the problems of TDS on interest earnings.

Therefore, on various parameters the Fixed Maturity Plans of mutual funds offer a better alternative to bank FDs.

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