NPS or Mutual Funds -
WHICH ONE TO CHOOSE FOR RETIREMENT?
Author: Dr. Renu Pothen, Research Head, Fundsupermart.com India
This article was published in Moneycontrol.com on Saturday, 06 October 2012
In continuation to my previous column that appeared on moneycontrol.com which was regarding the various pension schemes offered by mutual fund houses, I have been flooded with queries on these lines. The most common being: “If there are no good schemes in mutual funds for retirement planning, can we consider the National Pension System (NPS) made available by the government for the aam junta in 2009, or are there any other options in the mutual fund industry itself which investors can follow to plan for their golden years?”
Before providing suggestions to investors on the above queries, let me summarize my earlier piece for the benefit of those investors who have not yet glanced through it. I had touched upon the three pension funds available in the mutual fund industry and suggested that the veterans in the field that is UTI Retirement Benefit Pension Plan and Templeton India Pension Plan, should restructure their investment strategies and start showing performance so as to gain the confidence of investors. On the other hand, Tata Retirement Savings Fund runs on a good strategy but as the scheme is just about to complete a year, we will not be able to comment too much on the same.
NPS which was launched initially for the government employees in 2004 has been made available to all Indian citizens since May 1, 2009. Any individual in the age group of 18-60 years can subscribe to the scheme. NPS offers two accounts, namely, Tier-I Account which is the Retirement Account and Tier-II Account which will operate like a savings account. As far as the former option is concerned, investors cannot withdraw their savings till they attain the age of 60, while the latter account is optional and the savings accumulated in the same can be withdrawn at any point of time. Investors can also choose between the Active choice and Auto Choice options, as far as the investment approaches in the scheme are concerned. In the active choice, investors can decide on how their savings need to be allocated between the three asset classes available, i.e. Asset Class E (Equity Market Instruments), Asset Class C (Fixed Income Instruments other than Government Securities) and Asset Class G (Government Securities). Investors can take a 100 % exposure into Class C or Class G instruments but can invest only 50% of their corpus in Class E or choose to distribute their savings across these three asset classes. As for Class E instruments, the scheme considers only index funds which tracks the major indices, i.e. Sensex and Nifty. On the other hand, the auto choice option is for those investors who do not wish to take a call on their asset allocation but would like to depend on pre-determined portfolios. In this case, if the investor is entering at the age of 18, then he will have 50% of his portfolio concentrated in equities and 30% will be in Asset Class C and rest will be allocated in Asset Class G. This asset allocation strategy will remain the same till the investor attains the age of 36 and from thereon the investment in Class E and Class C will decrease annually and the allocation in Class G will increase substantially. Hence at the age of 55 years, the allocation in the different asset classes will be as follows: Class E (10%), Class C (10%) and Class G (80%).Now coming to the pension part; investors, when they reach 60 years of age, can withdraw 60% of the corpus either in a lumpsum or phased manner and the remaining 40% should be used to purchase annuity.
The advantages that this scheme offers is the low cost structure of 0.0009% p.a. and tax benefits under Section 80CCD(1) and Section 80CCD(2). However, on the other side, the biggest drawback of NPS is that this scheme currently falls under Exempt-Exempt-Tax (EET) category which will have to be modified to make it more attractive for retail investors. Another point that needs to be considered is the allocation of the equity instruments into just index funds. I am of the view that as the scheme is being managed by six prominent pension fund managers; they should be allowed to use their expertise to actively manage the equity portion rather than just relying on a passive strategy.
To the question on any other alternate options in the mutual fund industry, if one has to plan for retirement, my suggestion is that the investor should actually touch base with a good financial planner. The expert will then recommend a good portfolio of funds depending on factors like the age of the investor, amount of savings to be done each year, inflationary expectations, risk appetite, time horizon, etc. The only hitch here is that knowing our investors, the moment they see their portfolio either in red or green, they would immediately want to take an exit call and completely forget that it has been designed for their retirement. This is one big area where pension funds can score over actively managed portfolio of funds.
Another point that investors should keep in mind while going in for mutual fund schemes is that when they are young, their portfolio can be more biased towards the equity space and in that they can look at risky bets like mid and small cap funds, sector funds, etc. However, as they age, investors should slowly start rebalancing their portfolios towards more conservative funds like largecap funds, balanced funds and pure debt funds. In this way, as they reach retirement, they would have their entire corpus concentrated in debt funds.
Finally, I conclude this column by quoting a number which should ring a bell in investors’ minds of the advantages of following the virtue of patience while planning their investments. If an investor had put in a lumpsum of Rs 1 lakh each in four funds (Franklin India Bluechip Fund, HDFC Top 200 Fund, Reliance Growth Fund and HDFC Prudence Fund) 10 years back, then his accumulated corpus as on Oct 4, 2012 would have been Rs 54 lakh.