Thinking about life after retirement? To relax, travel and spend time with family or friends, an individual needs a reliable way to grow their savings.
With the recent updates in the National Pension System ecosystem, one can plan their investment strategies for wealth creation seamlessly. However, the way an individual invests their money matters in building a large retirement fund.
Let’s understand a few investment strategies to grow money with NPS Contributions.
Understanding Four Asset Classes
An individual needs to understand where the money is invested before he can build a strategy. When an individual makes an NPS contribution, the contribution is distributed across different types of asset classes based on the choice.
Here are the four categories one can choose from:
- Asset Class E (Equity): This is where your money is invested in the stock market. It carries the highest risk, but it may offer the highest wealth-building returns over the long run.
- Asset Class C (Corporate Bonds): Here, the money is invested to Corporate Bonds. It offers moderate returns with a medium level of risk.
- Asset Class G (Government Securities): Being one of the safest options, an individual’s money is invested in government bonds. The returns are generally lower than equity, but their capital is highly secure.
- Asset Class A (Alternative Investments): This includes modern investment vehicles like Invests in riskier, alternative instruments like Real Estate Investment Trusts (REITs), Infrastructure Investment Trusts (InvITs), and Commercial Mortgage-Backed Securities.
The "Auto Choice" Strategy
The Auto Choice strategy puts the investment on autopilot. All an individual needs to choose is risk appetite and the NPS system automatically adjusts their asset allocation based on their age. For example, when an individual is young, the Auto-choice strategy helps to invest more money into high-growth equity and as they get closer to retirement, it automatically shifts their funds into safer government securities to protect wealth.
You can select from three Auto Choice risk profiles:
- Aggressive Life Cycle Fund (LC75): Puts up to 75% of the money in equity until they turn 35, and then slowly reduces it.
- Moderate Life Cycle Fund (LC50): The default option which caps equity exposure at 50% until age 35.
- Conservative Life Cycle Fund (LC25): Caps equity at just 25% which is ideal for cautious individuals who prioritize the safety of their capital over high returns.
The "Active Choice" Strategy
If someone likes to have control and understands how financial markets work, the Active Choice strategy is where they belong.
This option gives freedom to design their own portfolio and get to decide the percentage of their NPS contribution that goes into Equity, Corporate Bonds, Government Securities, and Alternative Investments.
How to optimize Active Choice:
- The Rule of 75: The NPS scheme allows allocating a maximum of 75% of funds into Equity (up to age 50). If an individual is in their 20s, 30s, or early 40s, maximizing this 75% equity limit is recommended to beat inflation and create long-term wealth.
- The Rebalancing Act: Unlike Auto Choice, the system will not adjust the portfolio as per age. It is an individual’s responsibility to log in every few years and manually shift money from Equity (high risk) to Government Securities (low risk) as retirement approaches.
Approach to Contributions
One of the biggest mistakes an individual makes is keeping their contribution amount the same for years. If they started investing ₹5,000 a month five years ago, and if they are still investing ₹5,000 a month today, then they are falling behind inflation.
As the career progresses and salary increases, retirement savings should increase simultaneously.
- The Strategy: Commit to stepping up your NPS contribution by 10% every single year.
- The Impact: This increase in annual savings will trigger the compound interest, potentially adding more wealth to the final retirement corpus by the time an individual turns 60.
Evaluating and Switching Fund Managers
An individual’s money is handled by professional Pension Fund Managers (PFMs) appointed by the regulatory authority. However, not all fund managers perform similarly.
- The Strategy: Do not stay blindly loyal to your initial fund manager. The National Pension System allows changing the Pension Fund Manager. Review their historical performance online through the CRA portal or the fund manager’s website. If your current manager is consistently underperforming compared to the others, make the switch.
Maximizing the Tax Benefits
A good investment strategy is also about protecting the wealth from taxes. The NPS scheme offers a tax-saving structure that should be utilised to the maximum under the Old Tax Regime:
- Section 80CCD(1): Claim up to ₹1.5 lakh under Section 80CCD(1).
- 80CCD(1B): Claim an additional, flat ₹50,000 deduction exclusively for NPS under Section 80CCD(1B).
- If an individual is a salaried professional, they can contribute to NPS through their employer up to 10% for private and 14% for government employees of Basic + DA under the old tax regime and 14% of their Basic + DA for both private and government employees under the new regime.
Things to Avoid While Contributing to NPS
To ensure your strategy works smoothly, avoid these common errors:
- Putting 100% of your money into Government Securities when you are 25 years old may attract low returns.
- The value of your NPS equity portion might drop when the stock market dips. Do not panic and stop contributing, as market dips allow you to buy more units at lower prices, which leads to higher profits when the market recovers.
- Consider opening a voluntary Tier-2 account if you have extra cash that you might need before retirement.
Conclusion
With the latest updates, the National Pension System has become a flexible retirement investment plan available today. However, wealth creation depends entirely on the investment strategy an individual chooses for their NPS Contributions.
Whether they choose the convenience of the Auto Choice lifecycle funds or the control of the Active Choice model, the most important step is to make a conscious decision today.
Optimize your NPS Contribution strategy now and ensure a wealthy retirement corpus.
