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FDs can guarantee returns; fixed maturity plans cannot

The longer the duration, the higher the risks in such closed-end products

My mutual fund (MF) account statement says that if I redeem units within one year from the date of purchase, there would be a deduction of 1%. What does this mean?

—Naresh

MFs are allowed to charge what is termed as an exit load on redemptions made from a fund. This is levied to discourage short-term redemptions from the fund, which could affect the fund manager’s ability to manage the fund’s portfolio. Usually such charges are based on the duration between the date of investing and the redemption. For equity funds, the typical exit load clause is, as you say, a charge of 1% of the redemption amount if the redemption happens within one year of the investment. What this means is that the redemption amount will be lessened by 1% before it is paid out.

For example, you invest 1 lakh in such an equity fund that it grows to 1.2 lakh in nine months. If you withdraw all the units from your investment at this time, this withdrawal will incur an exit load penalty of 1,200 (1% of 1.2 lakh). Please note that every installment of a systematic investment plan (SIP) is treated as a separate investment for the purpose of calculating whether and how much exit load is applicable.

I would like to know how useful are closed-end debt schemes. I already have long running SIPs in equity funds and contributions to Public Provident Fund. I have recently started moving from fixed deposits (FDs) to debt funds.

—Sajid

Closed-end debt schemes, popularly known as fixed maturity plans (FMPs), are debt MF schemes that can be invested in only during their new fund offer period. These schemes carry a fixed term of investment (represented in number of days), and upon the end of this term, the proceeds (principal plus returns) will be automatically redeemed and deposited in the investor’s bank account. Since investors put money in these schemes for a fixed duration, they are often considered as MF equivalent of FDs. One point to note is that while FD products provide a guarantee of a certain percentage of return, FMPs are not allowed to do so. However, since FMPs take investors’ money and invest them in debt securities and hold these securities to maturity, one can mostly expect to get returns on par with the existing market interest rates at the time of investment.

Also, FMPs of more than a year’s duration provide indexation benefit. So, people in higher tax brackets can get better after-tax returns from FMPs than from FD products that do not provide such benefits.

While choosing an FMP, finding one with a duration that fits your investment need should be the first consideration. The longer the duration, the higher the risks in such closed-end products.

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