FMPs in the Portfolio

Fixed Maturity Plans(FMPs)

These products from Mutual Funds allow you to lock-in lumpsum amounts for a definite term. Although you do not know for sure how much you will be earning, one can be rest assured that a slice of bond market with certain maturities would normally generate a particular rate of return. one can make out the expected yield curve by studying the prior period yield curve allowing for changes expected. Even if you are not knowledgable investor, it is made easier by govt freeing small savings rate and the rate on post office savings deposits.
You get FMPs for any period, be it 1 month, 2 month, etc.. to 370 days, 390 days and even more.


LTCG Tax and FMPs

The CII is used to calculate what’s called the indexed cost of acquisition and this number bumps up the original price to match inflation.
The way you calculate the indexed cost of acquisition is by using the following formula:

Original purchase price x ( Index value in the current year / Index value in the original year)

In the case of FMPs, the original purchase price is nothing but the money you invested.
Let’s say you bought a FMP of a maturity of  370 days with Rs. 1 lakh in FY 2010 – 11 and sold it in FY 2011 – 12. To calculate the indexed cost of acquisition you will input the numbers in the above formula and get the new indexed value.
1,00,000 x (711 / 632) = 1,12,500
Let’s say after 370 days – the FMP rose to Rs. 1,12,500 which means it gained 12.5% in just over a year. To calculate the capital gains – you will need to subtract the indexed cost of acquisition with the selling price.
In this example both are the same so you won’t end up paying any tax.
There are a couple of things to keep in mind about this  – indexation only works for long term capital gains which accrue after you have held the FMP for a year, so that’s why you see a lot of FMPs that have a maturity period of slightly over 365 days.
Secondly, what Direct Tax Code eliminates is the double indexation benefit of FMPs which meant that you could buy something in March 2010 and sell it in April 2012 and make it span across two financial years. The DTC won’t allow this, but as far as I know FMPs will still be tax efficient when compared with fixed deposits because of the way indexation works.

FMPs and FDs

Both are fixed income alternatives but FDs come with pre-determined rate of return while the FMPs come with market based rate of return that is revealed at the end of the term.

The interest is taxed according to your tax slab in the FDs but LTCG advantages are available to your FMPs

ULIP Vs. Mutual Funds

How to understand these look alikes?

	ULIPs	Mutual Funds
Investment amounts	Determined by the investor and can be modified as well	Minimum investment amounts are determined by the fund house
Expenses	No upper limits, expenses determined by the insurance company	Upper limits for expenses chargeable to investors have been set by the regulator
Portfolio disclosure	Not mandatory*	Quarterly disclosures are mandatory
Modifying asset allocation	Generally permitted for free or at a nominal cost	Entry/exit loads have to be borne by the investor
Tax benefits	Section 80C benefits are available on all ULIP investments	Section 80C benefits are available only on investments in tax-saving funds

* There is lack of consensus on whether ULIPs are required to disclose their portfolios. While some insurers claim that disclosing portfolios on a quarterly basis is mandatory, others state that there is no legal obligation to do so.

 May be days will come with 100% portfolio disclosure for all the ULIPs as well. But does it affect the choice? As long as the investor is not having any say in portfolio management, all these standardised portfolios make no difference for the investor's choice.

Consider a person investing in a Mutual Fund scheme and another in an Insurance plan and watch the final outcome over a nine year period.


Look at the table:

Particulars	ULIP Invesor	Mutual Fund Investor
Plan	Invest 50,000 per year for retirement
Option	ULIP	Mutual Fund + Term plan for insurance cover
Insurance	5 lakhs	10 lakhs
Premium	Part of the money paid Ceases when fund>5lakhs.	Separately, Rs. 3,000 per year. 47,000 left for investment
Investment choice	ICICI Pru LifeTime	HDFC Equity Fund

Now look at what happens over the holding period?

For ULIP Investor
		Costs		Amount
Year	Invested	Upfront	Mortality	Left	NAV	Units	Total Units	Value
1	50,000	9,000	900	40,100	10.47	3,829.99	3,829.99	40,100
2	50,000	3,750	800	45,450	11.38	3,993.85	7,823.84	89,035
3	50,000	2,000	700	47,300	21.79	2,170.72	9,994.56	217,781
4	50,000	2,000	500	47,500	25.17	1,887.17	11,881.73	299,063
5	50,000	2,000	400	47,600	33.83	1,407.04	13,288.76	449,559
6	50,000	2,000	200	47,800	46.74	1,022.68	14,311.44	668,917
7	50,000	2,000	0	48,000	68.76	698.08	15,009.52	1,032,055
8	50,000	2,000	0	48,000	37.39	1,283.77	16,293.29	609,206
9	50,000	2,000	0	48,000	63.07	761.06	17,054.35	1,075,618
Total Invested		450,000
Total Commissions		26,750
Current Value		1,075,618
Mutual fund Investor :Term Plan + Mutual Fund
		Costs		Amount
Year	Invested	Upfront	Mortality	Left	NAV	Units	Total Units	Value
1	50,000	1,125	3,000	45,875	18.44	2,487.80	2,487.80	45,875
2	50,000	1,125	3,000	45,875	22.61	2,028.97	4,516.77	102,124
3	50,000	1,125	3,000	45,875	52.91	867.04	5,383.81	284,857
4	50,000	1,125	3,000	45,875	66.39	690.99	6,074.80	403,306
5	50,000	1,125	3,000	45,875	107.19	427.98	6,502.78	697,033
6	50,000	1,125	3,000	45,875	147.29	311.46	6,814.24	1,003,669
7	50,000	1,125	3,000	45,875	224.59	204.26	7,018.50	1,576,285
8	50,000	1,125	3,000	45,875	114.52	400.58	7,419.08	849,647
9	50,000	0	3,000	47,000	232.55	202.11	7,621.18	1,772,306
Total Invested		450,000
Total Commissions		9,000
Current Value		1,772,306

A combination of mutual fund/s and a term planworks out cheaper as the charges involved are only those for fund management and mortality. In an ULIP, however, there are charges on allocation, policy administration, mortality and fund management.
The new guidelines will stop ULIPs being positioned as short term investments products, and they will look less like mutual funds and more like insurance policies
Insights:

1) Do not bother about tax saving. So much has changed since I bought a product 9 years ago, and so much more will change going forward, all towards taxing of potential gains. The only thing one should care about is that investment mustn't be taxed while "accumulating" the growth - only when he/she exit. In that regard, fixed deposits are out.
2) Costs matter. The more one pay for a product, the more it hurts  later. In fact, a product that costs higher in the initial days seems to destroy your compounding potential.
3) Performance matters. While one might have chosen a badly performing fund and another person  a great one, in the end the fund that does better will win. But fund performance cannot be taken for granted or assumed, the only thing one must have is the ability to shift out of a badly performing product. With a ULIP you really don't have that freedom - you can't just shift to another ULIP without paying huge upfront costs.
4) Insurance and Investment are two different needs. The advantage of "insurance" was cursory - it was terribly inadequate with the ULIP in any case.

Decide for yourself. 

ULIPs are useful for small ticket insurance purposes. For those having insurance needs upto Rs15 lakhs appx. But for those need higher insurance cover,  should go for better options.

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