Today, when the financial world provides us with an endless horizon of investment options, finding the perfect investment model for you can be confusing, and even scary.
In this vast sea of investment options, mutual funds and fixed maturity plans have always caught the eye of investors looking for low risk assured returns and stability.
But still, there are a lot of questions on every investor’s mind about fixed maturity plans, with one of the main ones being: Is your money really safe in FMPs?
In this article, we’ll dive into the world of FMPs, see how they work, what the potential risks are, and whether they truly offer the safety that investors so eagerly seek.
Understanding Fixed Maturity Plans
What are Fixed Maturity Plans?
Fixed maturity plans are commonly known as FMPs. They’re a type of mutual fund, which are close-ended debt funds with a predetermined maturity date. This means that there is a fixed lock in period and a limited investment window.
These investment instruments pool funds from investors which are then invested in a portfolio of fixed income securities: these include your government bonds, corporate debentures, treasury bills, money market instruments, and so on.
FMPs have a fixed tenure, typically 1 to 5 years, and hence the name.
FMPs: How They Work
In a typical mutual fund, the asset management company (AMC), takes the investors’ money by selling units or shares and uses that money to make investments. For a 3 year closed fund, the AMC doesn’t give out or take back any new units or shares.
After the 3 year period ends, the asset management company can either turn the fund into an open ended fund, or pay the returns to the investors and close the fund.
Predetermined Maturity Date
FMPs work on one simple principle: Investors commit their funds for a specific period during which the fund manager uses that capital to various investment instruments, based on the fund’s investment objective.
The predetermined maturity date ensures that the fund remains close-ended, meaning investors can’t exit until the maturity period concludes.
Individuals can only invest in these FMPs during new fund offers (NFOs) made by asset management companies through subscription requests.
Are FMPs Safe? Assessing the Risks
Default Risk of Fixed Maturity Plans
The default risk associated with FMPs is one of the primary concerns that investors have. While these funds primarily invest in fixed-income securities with fixed maturities, the creditworthiness of the underlying bonds can pose a risk. FMPs with a higher exposure to lower-rated securities may have a higher default risk, affecting the investment’s overall safety.
Credit Risk in Fixed Maturity Plans
Investors should also consider the credit risk associated with FMPs. It is critical to conduct a thorough examination of the credit quality of the underlying securities. FMPs that invest in highly rated instruments are generally thought to be safer, as they protect against credit defaults and provide a more secure investment environment.
Liquidity Risk in Fixed Maturity Plans
Compared to open ended mutual funds, FMPs lack liquidity during their tenure. Investors who might want to make an emergency exit from the fund can face difficulties because of this strict nature of fixed maturity plans. Therefore, it is essential for investors to align their investment goals keeping in mind the fixed tenure of FMPs to mitigate liquidity risk effectively.
How Do FMPs Fare Against Traditional Options?
Industry consultants often draw comparisons between fixed maturity plans and the more traditional fixed deposits (FDs) when the safety of investments and risk is being evaluated.
While both options provide you with fixed tenure, FMPs have a definite edge when it comes to potential returns: they are exposed to a more diversified portfolio of debt instruments.
Fixed Maturity Plans (FMPs) | Fixed Deposits (FDs) | |
Nature | Close ended mutual fund investment with a fixed maturity date. | Bank deposit with a fixed tenure and interest rate. |
Tenure | Typically 1 to 5 years | Various tenures available, ranging from a few months to several years. |
Liquidity | Generally illiquid during the investment tenure. | Liquid, but early withdrawal may incur penalties. |
Risk Profile | Subject to market and credit risks | Generally considered low-risk with a fixed return |
Returns | Returns are market-linked and not guaranteed | Fixed interest rate offered throughout the tenure |
Interest Rate | Not fixed, investment returns are based on market conditions. | Fixed interest rate determined at the time of investment. |
Credit Risk | Depends on the creditworthiness of underlying securities | No credit risk; backed by the bank’s reputation |
Diversification | Offers diversification through a portfolio of debt instruments | Not applicable; individual deposit in a single bank |
Tax Implications | Taxation as per capital gains tax rules | Interest income is taxable; TDS may be applicable |
Flexibility | Limited flexibility during the investment tenure. | May offer flexibility in choosing tenure and interest payout frequency. |
Exit Options | Typically locked-in until maturity. | Premature withdrawal may be allowed with penalties. |
The Need for Caution: Safety of Money in FMPs
Safety of Principal
The safety of the principal investment in an FMP depends on the fund manager’s ability to make wise, sound investment decisions. Investors should search for fixed maturity plans with a track record of judicious investments, conservative portfolio management, and a focus on retaining capital while maximising reasonable returns.
Due Diligence
While invest and forget might work for some lucky investors, you must go beyond the gloss and glitter of promised returns, and understand the inherent risks.
Conducting due diligence on the historical performance of the fund, the portfolio composition, and the fund manager’s strategy can end up giving crucial insights about the investment landscape and lead to risk management.
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FAQs
What are FMPs?
FMPs are fixed-maturity mutual fund investments with maturities ranging from one to five years. They primarily invest in a fixed-income securities portfolio.
How do Fixed Maturity Plans work?
FMPs pool investor funds, which are then allocated to various debt instruments by the fund manager. The investment period is fixed, and investors are not permitted to exit before the maturity date.
What distinguishes FMPs from Fixed Deposits (FDs)?
FMPs are market-linked, with returns based on the performance of underlying securities, whereas FDs provide a fixed interest rate for the duration of the loan. FMPs have the potential for higher returns, but they are not without risk.
What are the risks associated with Fixed Maturity Plans?
Risks associated with FMPs include default risk, credit risk, and liquidity risk. The safety of money in FMPs relies on the fund manager’s ability to successfully manage these risks.
How safe are FMPs?
The safety of FMPs is determined by an investor’s risk tolerance and understanding of the risks involved. It is critical to do your research on the fund’s historical performance and portfolio composition.