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It's the right time to give your portfolio the fixed maturity plans edge

Prashant Mahesh, ET Bureau Feb 13, 2014, 06.55AM IST
(Experts feel investors…)

Several mutual funds such as Axis, ICICI Prudential, Reliance have recently launched fixed maturity plans (FMPs) of 410-430 days. According to investment experts, investors should consider investing in them, as they offer twin benefits of higher rate and almost nil tax due to double indexation benefit.

Experts say short-term interest rates are hovering at 9.20-9.50% and offer a great opportunity for investors to lock-in their money at these rates. Also, since these FMPs mature in April 2015, you get the benefit of double indexation.

"By investing in this financial year, investors will be eligible for double indexation. This will bring the tax impact to nil or very small, thereby making your entire return tax free," says Rupesh Bhansali, head (distribution), GEPL Capital.

Why FMPs Make Sense?

"Investments in 410-430 day FMP could earn you a return of 9.20-9.50%, as against a 10-year Government of India bond, which gives you a return of 8.75%," says Vikram Dalal, managing director, Synergy Capital. Many experts recommend locking in money at these current rates, as rates are likely to come down in the medium term. "As the inflation comes down, interest rates are expected to go down in the second half of the year," says Rohini Dhar, managing partner, Cogent Advisory. However, experts advise investors to keep their liquidity needs in mind while investing in FMPs. FMPs, even though they are listed, are illiquid and an exiting them before maturity may be tough. In short, the advice is to invest in FMPs only if you can hold your investment till maturity.

Advantage Of Double Indexation

Your investment will qualify for double indexation when you invest closer to the end of a financial year and exit soon after the end of next financial year. For example, if you invest in one of these FMPs now (February 2014) and sell it in April 2015, it qualifies for double indexation.

Assume you invest Rs 1 lakh in a 420-day FMP in February 2014. Chances are you could earn 9.2-9.5% for 365 days (1 year), extrapolating this calculation to 420 days, you will earn approximately 11% on your total investment. This means you will earn Rs 11,000 as capital gains on your investment of Rs 1 lakh that you have made for 420 days. Or your total investment value is Rs 1,11,000 in April 2015.

Now, since you can claim double indexation benefit, the value of your Rs 1 lakh investment would be Rs 1,14,483. This is how it works: The government releases cost inflation index (CII) every year to adjust the cost of purchase of an asset to reflect inflation. The CII for the year 2013-14 is Rs 939. Assuming a conservative 7% inflation for the next two years, CII for 2014-15 will be Rs 1,005 and Rs 1,075 for 2015-16. When the FMP is redeemed in April 2015, you can also take into account the CII of 2015-2016.

This is because even though you have held your investment only for 420 days, you get the benefit of CII number for three years. So, the final value of your investment is Rs 114,483 ( Rs 1 lakh multiplied by CII at the time of sale (Rs 1,075) and divide it by CII at the time of purchase.

Now, here is the tax calculation: Subtract the new figure from the actual capital gain that you have made. The capital gain after providing for double indexation works out to a capital loss of Rs 3,483 ( Rs 1,11,000 minus Rs 1,14,483), which makes tax liability nil.

In fact, you can even carry forward this loss for eight years and set it off against long-term capital gain.