FMPs Loose Shine

In our March 29th issue, we argued that bank deposits are better than fixed maturity plans (FMPs) which were being pushed aggressively by mutual funds because the returns from an average FMP is no better than bank FDs. After interest rates on bank deposits started surging since late last year and after the Budget
of 2007-08 reduced the tax attractiveness of FMPs, it made even less sense to go for FMPs.

A couple of readers criticised this argument. They pointed to the high post-tax returns of FMPs as an argument in their favour.
This is the most common trap that investors fall into: assuming that the recent high rate of returns will continue. It is called the “recency effect”. One writer even suggested that we were singing the praises of FDs and dishing FMPs at the behest of banks.

FMPs are income schemes mostly of a closed-end nature that invest in fixed-income paper like bonds, government securities and money market instruments. Banks today offer anywhere between 9%-10% on fixed deposit schemes of up to 18 months. How were some FMPs able to beat that return in the past? Will they be able to offer, say, a 12% tax-free return, keeping their recent lead over FDs?

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