Should you roll over your 1-year FMP?

The decision will depend on the tax bracket you fall in

The period between January and March typically sees an uptick in the launch of fixed maturity plans, or FMPs. Not  this year. Instead, fund houses are busy rolling over or extending the tenure of their one-year FMPs launched last year to three years.

Investors in one-year FMPs have a choice. Either redeem units or roll over to three years. If you exit now, your gains will be added to your income and taxed in line with your individual slab rate of 10, 20 or 30 per cent. If you stay invested for two more years, you pay 20 per cent tax with indexation benefit.

“Yields have softened in the past few months on expectations of a rate cut. If the central bank continues its soft monetary stance, yields are likely to fall further. In such a scenario, it makes sense for investors, particularly those in the 30 per cent tax bracket, to roll over their investments and lock in at a higher yield now,” said R Sivakumar, head of fixed income at Axis MF.

In a surprise move, the Reserve Bank of India cut repo rate by 25 basis points to 7.75 per cent on Monday.

Those rolling over their investments should note FMPs will give them lower returns compared to last year. For instance, one-year certificate of deposits were ruling at 9-9.5 per cent in 2014. At present, yields of two-year AAA- and AA-rated corporate bonds are 8.5-8.7 per cent.

Rollovers are most beneficial to investors in the 30 per cent bracket. Those in the 10 per cent bracket, on the other hand, can exit as they will not be impacted by the change in rules.

Investors in the 20 per cent bracket choosing to roll over will be impacted marginally, to the extent of the indexation benefit. So, besides the taxation aspect, these investors should take into account the expense structure for the rollover period, credit quality of the new portfolio, and other competing debt options before deciding to roll over, says Rakesh Nangia, founder of Nangia & Co.

Financial planners believe investors will be better off exiting their investment and deploying the money in open-ended bond funds. “FMPs employ a buy-and-hold strategy and might not give high returns unless they invest in lower-rated papers. Open-ended bond funds can provide better capital appreciation opportunities in a falling interest rate scenario,” says Vidya Bala, head of mutual fund research at FundsIndia.com.

Mahendra Jajoo, a former fixed income manager, suggests rolling over 60 per cent of FMP investment and putting the rest in bond funds. “Bond funds will give a kicker to your portfolio. One can invest for two years and then extend it to three years, depending on the interest rate outlook prevailing at the time,” says Jajoo.

According to Value Research, short-term and as well as long-duration bond funds have given double-digit returns in the past year.