The Hindu Business Line : Fund Talk

Both bank deposits and fixed maturity plans from mutual funds are superior and relatively safe options for you to park your money until you require it. Your choice between the two should depend on your risk appetite and tax status.

I am going to retire in two years. Now I am shifting towards safe investments with moderate risk. Please guide me whether balanced fund such as HDFC Prudence/FT India Balanced Fund can deliver better returns than term deposits with banks which are now generating 10-10.5 per cent? After paying income tax, I earn 7 per cent in term deposits held with banks. Would Fixed Maturity Plans be a better option than Term Deposits? How is the income from FMPs taxed?

Asok Biswas

Since your investment horizon is only two years, we would not advise you to move your money into any fund with a substantial equity component. Most balanced funds invest over two-thirds of their portfolio in equities and thus do carry some downside risk.

If the stock market should enter a bearish phase over the next two years, you may not have sufficient time to wait for the market to recover, to recoup your investments. Both bank deposits and fixed maturity plans from mutual funds are superior and relatively safe options for you to park your money until you require it. Your choice between the two should depend on your risk appetite (FMPs carry slightly higher risk than fixed deposits) and your tax status (FMPs are more tax efficient).

First, you have to note that, though FMPs provide investors with an "indicative" yield at the time of investment, the actual returns generated by the fund may vary slightly from the indicative yields. This is because, unlike bank FDs, FMPs invest in market-related instruments and therefore generate returns that are close to prevailing market rates at the time of the launch.

However, FMPs reduce the impact of fluctuating interest rates on your returns by investing only in debt securities that broadly match the maturity profile of the scheme. Returns from FMPs will generally match the indicative yields provided; but are not "assured" as in the case of bank deposits.

Second, Fixed Maturity Plans are a more tax efficient way to earn returns than bank FDs, for investors in the higher tax slabs. Your interest receipts from a bank deposit are treated as part of your total income and taxed at your marginal rate of tax, which could be 20 or even 30 per cent plus surcharge and cess. However, dividends declared by FMPs are tax-free in your hands.

The fund bears an effective dividend distribution tax of 14.2 per cent on the dividends declared. But the final return to you will still suffer a lower tax incidence than it would, at your marginal rate of tax.

For FMPs held for more than a year, the returns earned at maturity are treated as capital gains and taxed at 10 per cent (without indexation benefits) or at 20 per cent (with indexation benefits).

Some FMPs launched towards the end of the financial year offer double indexation benefits (returns can be adjusted for the inflation index for two years, instead of one) which further reduces the effective tax on your returns. You can refer to the article on FMPs on Page 13 for further elaboration.

Given the risk-return trade off that you would like to make, you can spread your investments between FMPs and bank deposits, either equally or in proportions of your choice.

Queries may be e-mailed to mf@thehindu.co.in,

or sent by post to Business Line,

859- 860, Anna Salai, Chennai 600002.

Aarati Krishnan

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