How to select the correct asset allocation strategy for your NPS investment?

How to select the correct asset allocation strategy for your NPS investment?

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NPS or National Pension System is one of the highly focused retirement products that does the task of providing an income source in the form of pension during your old age. As your earnings in the scheme are in tune with market returns, you hold the chance of earning higher returns over the long term to create an adequate post retirement corpus. However, sadly, many retail investors invest in National Pension Scheme to just avail the additional Rs. 50,000 tax deduction as per Section 80 CCD (1B). Note that this is an extremely incorrect approach for selecting any investment product for investment purpose.

What steps should you adopt to select the correct asset allocation strategy for your NPS account (basically for the Tier 1 account)?

National Pension Scheme is a well-defined contribution system where you make regular investments and returns that you avail during the scheme tenure depending on the asset allocation portfolio and returns generated by the underlying assets.

Auto vs active choices

As per auto option in NPS, you do not require making any asset allocation strategy decision. Investments are made in any of the 3 available LC (Life Cycle) funds as selected by you and the proportions of every asset class is predetermined. The 3 LC funds include:

  • Conservation LC fund: This fund comes with an upper limit on equities of 25% up to the age of 35. Afterwards, it moves down to 5% by 55 years of age.
  • Moderate LC fund: This fund comes with an upper limit on equities of 50% for up to the age of 35. Afterwards, it goes down to 10% by 55 years of age.
  • Aggressive LC fund: This fund comes with an upper limit on equities of 75% up to the age of 35. Then, it moves down to 15% by 55 years of age.

As per the auto option in NPS, you get the choice to select your asset allocation strategy. However, there are certain limits. NPS accounts have a maximum of 75% cap towards equity investments up to the age of 50. After 50 years of age, the upper equity limit tapers off by 2.5% every year until it reaches 50% by 60 years of age.

As per your suitability, you can choose between the NPS options and switch between the options in a financial year basis your requirement.

How should you select the correct asset allocation strategy for your NPS investment?

The first and foremost thing to note is that the National Pension System must be a part of your retirement portfolio and should not be done randomly as a standalone investment.

Young investor (20s – 30s)

If you fall in the age group between 20s and 30s, you should be very aggressive with retirement investments (unless you are a risk averse investor). Your investments must have a huge allocation towards equities. It can be done through pure equity funds.

In simpler terms, if you are contributing an adequate investible amount towards EPF and look to add in another investment option for retirement corpus generation, NPS can be a prudent choice wherein your asset allocation can be equity bias in the initial stage at least. It is because at a young age, many generally have lower financial obligations to serve than mid or old age groups. This means, you have a higher scope to invest for post-retirement corpus generation when you are young.

Mid and old age investor (40s and above)

If you are in your 40s or higher, like most investors, you too may also have a huge allocation to debt investments through PPF and EPF. Adding National Pension Scheme here with high equity allocations as per your risk appetite can help you attain your retirement corpus faster. However, in case your provident fund corpus is not huge and instead you have a higher proportion of funds invested in equity, you can become conservation with NPS and consider it as a debt option by allocating higher funds towards debt schemes.

Conclusion

NPS is a crucial retirement financial instrument that in recent times has evolved into a highly tax efficient, flexible and wealth generating option. To avail these benefits, you should embed it in your retirement portfolio and pick an allocation that can help you attain the targeted post retirement corpus within the estimated time.

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