The markets have been giving shudders to the investors for a long while now, most have lost faith in Sensex, while most have become skeptical. The ‘Relationship Managers’ (RM) are after every person who seems to smell of cash. Mutual Funds, Insurance, ULIPs, loans are all being coaxed using telemarketing. The advisors and RMs would suggest that this is the time to actually invest in market as you will lose the opportunity once its up and appealing but the fear of losing always above then the lust for more, keeping the public away. So for risk averse people what are the investment options available right now.
For a risk averse investor the main aim is to save the assets from monetary erosion. So the investment options to be evaluated are the ones having low risk of erosion and almost gurantee of full cash back (atleast) in event of further weakening of economy. There are many instruments for investing where the return is more or less guranteed. The top choice these days is Fixed Deposits (as evident on the billboards). Bank deposits are the safest investment after Post office savings because all bank deposits are insured under the Deposit Insurance & Credit Guarantee Scheme of India. With effect from A.Y. 1998-99, investment on bank deposits, along with other specified incomes, is exempt from income tax up to a limit of Rs.12, 000/- under Section 80L. Also, from A.Y. 1993-94, bank deposits are totally exempt from wealth tax. The 1995 Finance Bill Proposals introduced tax deduction at source (TDS) on fixed deposits on interest incomes of Rs.5000/- and above per annum. But banks are not the only option for FD, you can go for post offices FD and FD given by the companies.
Another option that has got very popular recently is Fixed Maturity Plan (FMP). In FD, said above, your return is taxable in case interest is more than Rs. 5000 per annum (per FD). Thats where FMP starts shining in investors eyes. FMPs, as they are popularly known, are the equivalent of a fixed deposit in a bank, with a caveat. The maturity amount of a fixed deposit in a bank is ‘guaranteed’, but only ‘indicated’ in the FMP of a mutual fund.
FMPs are debt schemes, where the corpus is invested in fixed-income securities. The tenure can be of different maturities, from one month to three years. They are closed-ended in nature, which means that once the NFO (new fund offer) closes, the scheme cannot accept any further investment. The magic is in the tax treatment of a mutual fund FMP. FMPs are classified under the debt scheme category and enjoy certain tax benefits, such as:
- Dividend in the hands of the investor is tax-free. But the mutual fund has to deduct a dividend distribution tax of 14.025 per cent in the case of individuals and Hindu Undivided Families (HUFs), and 22.44 per cent in the case of corporates.
- Long-term capital gains (investment of more than a year) enjoy indexation benefit.
- Short-term capital gains are added to the income of the investor and taxed as per his/her slab, whereas the interest on a bank deposit (except where special 80C approved) is added to the income of the investor and taxed as per his/her slab.
So going for a long term FMP (more than one year) the return on the FMP will be say 10% – .14025(10%); while that in FD will be 10%-.33(10%) essentially giving a return of 8.5975 – 6.6667 = 1.93%
Below is another pull up from Rediff to explain it further:
What is indexation benefit?
The finance minister has been generous enough to recognise that inflation erodes the real value of any investment. So every year, he comes out with an inflation index based on the prevailing rate of inflation. The cost of investment is indexed by multiplying the index of the year of maturity and divided by the inflation index prevailing on the year of investment. If you have arrived at an indexed cost, then the long-term capital gain is taxed at 22.44 per cent and if you do not opt for the indexed cost, then the tax is 11.22 per cent.
How does this pan out?
Take an example of a 30-month FMP which, if launched now, will mature in June 2009. It will pass through three financial years – launch in 2006-2007 and maturing in 2008-2009. Thus, it can have a benefit of triple-cost indexation for the purpose of calculating post-tax yield. Look at the workings: Note: Cost Inflation Index for FY06-07 is 519. The assumption is that the CII for FY07-08 is 567 and for FY08-09 is 592. Clearly, the post-tax return is superior for an FMP. Simran was convinced of its benefits and was gung-ho about investing in it.
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Bank Fixed Deposit
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30 Month FMP
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With Indexation
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Without Indexation
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Amount of Investment (Rs.)
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10000
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10000
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10000
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Post Expenses Yield (p.a)*
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8.30%
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8.30%
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8.30%
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Tenor (in months)
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30
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30
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30
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Approx Maturity Amt
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12,075
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12,075
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12,075
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Gain
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2075
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2075
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2075
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Indexed Cost
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NA
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11,406
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NIL
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|
Indexed Gain
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NA
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669
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NA
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Tax Rate
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33.66%
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22.44%
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11.22%
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Tax
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698
|
150
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232
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|
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|
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Post Tax Gain
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1377
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1925
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1843
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|
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|
|
|
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Approx Post Tax Annualised Return
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5.5%
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7.7%
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7.3%
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Source: Rediff article
Happy Investing!
PS: I would like to thank Tabassum Shaikh, RM (HSBC) for introducing me to benefits of the FMP and indexation.
