Fixed maturity plans v/s short-term bonds: Safer investment?
What's the story
Fixed maturity plans (FMPs) and short-term bonds are two popular investment options for those looking for safety and stability. Both provide lower risk than equities, but differ in how they function and the returns they provide. Knowing these differences can help you choose the right investment for your goals. Here's a look at how FMPs and short-term bonds stack up against each other.
#1
Understanding Fixed Maturity Plans
FMPs are closed-end debt funds with a fixed tenure. They invest in fixed income securities with similar maturities as the fund's term. Since they hold till maturity, FMPs give predictable returns, which are usually higher than traditional savings accounts. They are tax-efficient if held for more than three years, thanks to capital gains tax benefits.
#2
Short-term bonds explained
Short-term bonds are debt instruments with maturities of one to five years. They pay periodic interest and return the principal at maturity. Unlike FMPs, short-term bonds can be traded on exchanges before maturity, giving liquidity but also market risk. The returns from these bonds depend on interest rate movements and credit risk of issuers.
#3
Comparing returns and risks
FMPs generally offer higher returns than short-term bonds as they invest in higher-yielding instruments like corporate debt. However, they come with lower liquidity since you can't redeem them before maturity without penalties. Short-term bonds offer more liquidity but may have lower returns due to their periodic interest payments and exposure to interest rate risks.
#4
Tax implications for investors
Investors should also consider tax implications when choosing between FMPs and short-term bonds. FMPs held for more than three years qualify for long-term capital gains tax at 20% with indexation benefits, reducing taxable gains over time due to inflation adjustments. Short-term bond interest is taxed as per the investor's income slab, which may be higher than FMPs' effective rate after indexation benefits are applied over time.