How an investment made by a person is put to use determines the returns and risks associated with that investment. This is how it works – the investor makes a purchase of an asset, and according to the returns, the investor is paid an interest along with the amount initially invested. Hence, it is essential to understand who makes the purchase of an asset, and what is the nature of this asset.
With respect to these factors, let’s understand how fixed maturity plans (FMPs) and fixed deposits (FDs) work.
Consider that you make an investment in a fixed deposit. What this means is you have lent money to a bank. Furthermore, the bank makes use of this money to give loans. Thus your investment is an asset of the bank. According to the various terms and criteria of a bank, it decides who is eligible for a loan, rate of interest, and terms of recovery.
For you, the concern remains that the bank makes loans to reliable borrowers, thus ensuring that it will pay back on your investment. Due to the strict regulations in banks, such a risk is really low as long as you go to a credible and well-known bank.
Now the other alternative for you would be to invest in an FMP. These are close-ended debt funds in which you can invest in only during the time of a new fund offer.
Hence in an FMP, the investment is made in a mutual fund. Now the managers of the mutual fund purchase bonds from various borrowers. The manager may also invest in a bank’s certificate of deposit (CD) – the facility with which a bank borrows money. Additionally, a fee is charged by the fund managers for their financial services given to the investor.
So in the case of a fixed deposit, you are enabling a bank to give a loan. However, in the case of an FMP, you may be in the same market as a bank, in giving a loan. Before paying an investor the interest a bank will be recovering certain costs, which may be about 3-4%. But for an FMP the costs recovered by the managers of funds would be only around 0.5 – 2%.
Thus if an individual goes with a reputable fund house that has a good investment record, and invests responsibly, FMPs can be a beneficial investment option.