The NPS (national pension system) no doubt has its limitations in the form of illiquidity and constraints on asset allocation. But NPS is probably the only retirement-focused product that does the job of installing a real source of reliable pension during your non-working years. This can be good for many savers who may find it hard to generate regular income from their retirement corpus. So, may be, the NPS doesn’t get the attention it deserves.
But sadly, many invest in it only to get that extra (and exclusive to the NPS) tax deduction of Rs 50,000. And that is a wrong approach when choosing products to invest in.
How should you be choosing the right asset allocation for your NPS account (primarily Tier 1 account)?
NPS is a defined contribution plan where you make regular contributions and the returns you generate during the NPS tenure depend on the portfolio asset allocation and the returns delivered by the underlying assets.
Active and auto choices
I have already written about the investment options Active vs Auto in NPS.
In the NPS (Auto Choice), the subscribers don’t have to do make any asset allocation decisions. The investments are made in one of the three available Life Cycle Funds (LC) as chosen by the subscriber and the percentages of each asset class is pre-decided. The three LC funds are:
-Aggressive Life Cycle Fund (LC75): Has an upper cap on equity of 75 per cent up to age 35. Afterward, it tapers down to 15 per cent by the age 55.
-Moderate Life Cycle Fund (LC50): Has an upper cap on equity of 50 per cent up to age 35. Later, it tapers down to 10 per cent by the age 55.
-Conservative Life Cycle Fund (LC25): Has an upper cap on equity of 25 per cent up to age 35. Later, it tapers down to 5 per cent by the age 55.
In the NPS (Active Choice), the subscribers get to choose their asset allocation. But there are still certain limits. The NPS account can have a maximum of 75 per cent in Asset Class E (Equity). And after the age of 50, the upper limit of equity tapers by 2.5 per cent each year till it reaches 50 per cent by age 60.
With that said, how should you choose the asset allocation for your NPS savings?
The very first thing to keep in mind is that NPS should be a part of your overall retirement savings portfolio and not a standalone investment done randomly.
This also means that the allocation to NPS must fall within your overall asset allocation (which includes investments in EPF, PPF, Equity funds and NPS).
Choosing the right allocation
That said, here are few pointers to help you make the right asset allocation call for your NPS savings:
-If you are young, i.e., in your 30s or early 40s, you can and should be quite aggressive with your retirement savings (unless you are a conservative saver). So your investments should have a large allocation to equities. This can be done via pure equity funds easily. But assuming you are already contributing to EPF sufficiently and now also want to include NPS in the mix, then your NPS asset allocation can have a high equity bias at least initially.
-If you are in your mid-40s or higher, and already have a large allocation to debt savings (via EPF and PPF), then you too can have NPS with high equity allocation (as high as permitted), so that the overall retirement portfolio has reasonable equity allocation.
-But if your PF corpus isn’t very large, and instead you have tons of money in equity funds, then you can be conservative with NPS and treat it as part of the debt side of your retirement corpus.
So, the primary idea is to embed the NPS in the overall retirement savings plan and then pick such an allocation that it will help you achieve the targeted retirement corpus in the available time with high probability (and without being financially too adventurous).
Let’s take a hypothetical example. Suppose you have Rs 25 lakh in retirement savings, with Rs 10 lakh in EPF + PPF and Rs 5 lakh in equity funds. Now how do you pick the asset allocation for Rs 10 lakh in NPS?
-If you are a conservative investor, let’s say you want 30 per cent equity in the portfolio. So on a Rs 25 lakh total portfolio, you need Rs 7.5 lakh in equity. Now, Rs 5 lakh is already invested in equity funds. The remaining Rs 2.5 lakh can come by having 25 per cent equity allocation to NPS.
-If balanced to (occasionally) moderately aggressive investor, let’s say you want 50 per cent equity in the portfolio. So, on a Rs 25 lakh total portfolio, you need Rs 12.5 lakh in equity. The Rs 7.5 lakh can come via having 75 per cent equity in NPS (or as much equity as possible given the age-related allocation restrictions).
These are general approaches. Given the unique requirements of individuals, the actual approach may differ for everyone. Do take investment advice from a good investment advisor if you wish to get some help to plan your retirement corpus properly.
(The writer is the founder of StableInvestor.com)