In India, NPS is one of the very few (if not the only) products that is retirement-focused and aims to provide pension income during retirement years. But most people look at NPS from the lens of extra tax saving, where an additional ₹50,000 deduction is offered exclusively under Section 80CCD(1B) for NPS Tier-1 contributions.
In my view, NPS, as a retirement product, can be suitable for a small subset of investors if not everyone.
But different people require different strategies to fit NPS into their retirement plans. NPS offers both active and auto choices for portfolio allocation management. Let’s see which option works best for whom.
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4 assets/schemes of NPS
NPS investors have access to 4 asset classes via 4 schemes, namely:
· Scheme E (made up of Equity)
· Scheme G (made up of Government Debt)
· Scheme C (made up of Corporate Bonds)
· Scheme A (made up of Alternative Investments like REITs, Invits, AIF, etc.)
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Active vs auto choices of NPS
The investments in/among these 4 options (listed above) can be managed in 2 ways – The first approach is the AUTO choice. The second one is the ACTIVE choice.
The fundamental difference between these 2 options is that active choice is for those who want to actively (on their own) manage NPS asset allocation. On the other hand, the auto choice is managed without the investor’s inputs and automatically based on a pre-decided formula.
Let’s deep dive a bit more in the two choices:
NPS auto choice
This is the automatic option to manage the NPS asset allocation. The subscribers themselves don’t have to take any asset allocation decisions. The allocation is decided based on the life-cycle (LC) funds that have been chosen. And there are 3 Life Cycle Funds to choose from:
· Aggressive Life Cycle Fund (LC75) – Best suited for aggressive investors who need high exposure to equity. The automated schedule of LC75 allows 75% equity up to the age 35. After that, it gradually tapers down to 15% by the age 55. The pace of reduction in equity allocation is -4% from age 35 to 45, followed by -3% from age 45-50, and then -1% from 50 to 55 to stabilise at 15%. And it stays at 15% thereafter.
· Moderate Life Cycle Fund (LC50) – Best suited for investors who are balanced or moderately aggressive. The automated schedule of LC50 allows 50% equity up to the age 35. After that, it gradually tapers down to 10% by the age 55. The pace of reduction in equity allocation is -2% from age 35 to 55. Once it reaches 10% at age 55, it stays at 10% thereafter.
· Conservative Life Cycle Fund (LC25) – As the name suggests, it is for conservative investors only. The automated schedule of LC25 allows 25% equity up to the age 35. After that, it gradually tapers down by -1% every year from age 35- to 55 to reach 5% at age 55.
Under auto choice, the rebalancing (to reduce equity to pred-decided levels as explained above) is done once a year on the date of birth of the NPS account holder.
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NPS active choice
In the Active choice, the subscribers have the freedom to actively decide the NPS asset allocation (and ratio among various assets/schemes) by themselves based on their understanding.
One can have a maximum of 75% in equity (scheme E) till age 50. After that, there is -2.5% reduction in upper cap every year on equity exposure. So, at age 51, you can have a max exposure of 72.5% to equity. At age 52, it can be 70% and so on. This continues till age 60 when the upper cap becomes 50
Choosing between active vs auto choice in NPS
If you have a good enough understanding of various assets, risk-return tradeoffs and have the time to manage your financial asset allocation, then you can opt for active choice. But if you are unable to do so and don’t want to get into asset allocation, rebalancing, etc. every year, then its best to go for the auto choice.
Also, it’s not that the decision is irreversible. NPS allows you to change from active to auto or vice versa once a year if you want. So, you can start with one option and then switch to the other if it is not working out for you.
In any case, irrespective of whether you go for auto or active choice, please make sure that your NPS asset allocation is part of the overall retirement portfolio and its allocation.
Dev Ashish is a SEBI-Registered Investment Advisor and Founder (Stable Investor). He provides fee-only financial planning and investment advisory services to small and HNI clients across India.