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Navigating NPS Investment Options: Discovering the Right Path to a Secure Retirement


Introduction:

In the realm of financial decision-making, individuals have different preferences when it comes to making choices. The National Pension System (NPS) acknowledges this diversity and offers two investment options to its subscribers: Auto Choice and Active Choice. Auto Choice is designed for passive investors who prefer a hands-off approach, while Active Choice empowers subscribers to take control of their investments. This article delves into the details of these two NPS investment options, providing insights into asset classes, allocation strategies, and the flexibility to switch between options.


NPS Investment Options and Asset Classes:

NPS subscribers can allocate their savings across four asset classes: Equity, Corporate Debt, Government Bonds, and Alternative Investment Funds. These choices are made possible through the seven pension fund managers authorized to manage NPS funds. Each asset class has specific investment guidelines defined by the regulatory body. Equity investments predominantly involve investing in equity market instruments, while corporate debt focuses on bonds issued by public sector undertakings, financial institutions, infrastructure companies, and money market instruments. Government Securities refer to securities issued by the central and state governments, along with money market instruments. Alternative Investment Funds involve instruments like CMBS, REITs, and AIFs.


​Asset classes offered by Pension Fund Managers (PFMs) for investment

Equity (E)

Scheme invests predominantly in Equity market instruments.

Corporate Debt (C)

Scheme invests in Bonds issued by Public Sector Undertakings (PSUs), Public Financial Institutions (PFIs), Infrastructure Companies and Money Market Instruments

Government Securities (G)

Scheme invests in Securities issued by Central Government, State Governments and Money Market Instruments

Alternative Investment Funds (A)

​In this asset class, investments are being made in instruments like CMBS, REITS, AIFs, etc.


Active Choice in NPS:

Active Choice is designed for NPS subscribers who wish to have control over their asset allocation. Under this option, subscribers can decide the ratio in which their contributions will be invested across the various asset classes. However, there are limitations within Active Choice. The maximum allocation to equities is currently set at 75%, although this limit has been increased from 50% based on subscriber feedback. Active Choice offers flexibility, but it also carries higher investment risks and potential returns, depending on the asset class.

Active investment Class

Government (G)

Corporate (C)

Equity (E)

Investment Return (potential)

Low

Medium

​High

Investment Risk

Low

Medium

High

Permissible allocation

Up to 75%

Up to 100%

Up to 100%

Active choice in the National Pension System (NPS) refers to the option provided to subscribers to actively manage their investment portfolio. NPS is a government-backed pension scheme in India that allows individuals to contribute towards their retirement savings.Under the active choice option, NPS subscribers have the freedom to allocate their contributions across different asset classes such as equity, corporate bonds, government securities, and alternative investment funds. They can choose the percentage of their contributions to be invested in each asset class based on their risk appetite and investment goals.


By opting for the active choice, subscribers take on the responsibility of monitoring and rebalancing their investment portfolio periodically to align with their desired asset allocation. This option gives them more control and flexibility in managing their retirement savings within the framework of the NPS. It's important for NPS subscribers opting for the active choice to be knowledgeable about investment strategies, market trends, and risk management to make informed decisions and maximize their retirement savings. It is advisable to consult with a financial advisor or asset management professional to make the most suitable investment choices based on individual circumstances and goals.


Auto Choice in NPS:

Auto Choice is suitable for passive investors who prefer a more hands-off approach. It employs a life-cycle-based allocation strategy, where the proportion of funds allocated to different asset classes changes as the subscriber ages. Initially, the portfolio is equity-heavy during the subscriber's younger years and gradually reduces equity exposure as retirement approaches. The objective is to optimize returns while cushioning against market volatility.


The auto choice option is further divided into three lifecycle funds:

  1. Aggressive Lifecycle Fund: This fund is suitable for younger subscribers with a higher appetite for risk. In this option, a higher percentage of the investment is allocated to equity assets in the initial years to potentially achieve higher returns. As the subscriber's age progresses, the allocation to equity gradually decreases and shifts towards less risky instruments such as government securities and corporate bonds.

  2. Moderate Lifecycle Fund: This fund is designed for subscribers with a moderate risk appetite. The asset allocation is relatively balanced between equity and fixed income instruments throughout the subscriber's investment tenure.

  3. Conservative Lifecycle Fund: This fund is suitable for subscribers closer to their retirement age or with a lower risk tolerance. The allocation to equity is relatively lower, and a significant portion is invested in fixed income instruments to provide stability and income generation.

Under the auto choice option, the asset allocation automatically adjusts based on the subscriber's age. The investment strategy is managed by professional fund managers appointed by Pension Fund Regulatory and Development Authority (PFRDA). Subscribers opting for the auto choice do not need to actively monitor or rebalance their portfolio. The investment decisions are made on their behalf to align with their risk profile and expected retirement goals. However, subscribers can switch from auto choice to active choice at any time if they prefer to manage their investments actively. It is important for NPS subscribers to understand the features and implications of the auto choice option before making a decision. Assessing one's risk tolerance and retirement goals is crucial in choosing the most suitable investment approach within the NPS framework. Consulting with a financial advisor can provide further guidance based on individual circumstances.

NPS Investment Options

Flexibility to switch NPS investment option

- NPS subscribers have the freedom to choose their preferred investment option and fund manager.

- Fund manager can be changed once a year, and the scheme of investment can be changed four times a year.

- Switching options are available for investments in NPS Tier I (non-government subscribers only) and NPS Tier II accounts.

- These features offer alternatives based on life stage and desired asset allocation.

Comparing Auto Choice and Active Choice:

While Active Choice allows for greater control over asset allocation, both options have limitations on equity exposure. Active Choice permits a maximum equity allocation of 75%, whereas Auto Choice gradually reduces equity exposure as retirement approaches, even in the Aggressive Life Cycle Fund. The rationale behind this approach is to minimize the impact of volatility on equity investments as subscribers near retirement. Subscribers who wish to have complete control over their investments and are willing to manage the asset allocation actively may prefer Active Choice. On the other hand, those who prefer a passive approach or find it challenging to decide may opt for Auto Choice initially, with the flexibility to switch to Active Choice later.


Flexibility to Switch NPS Investment Option:

NPS offers subscribers the flexibility to change their investment options and fund managers based on their preferences and investment goals. Subscribers can switch their fund manager once a year and change their scheme of investment four times a year. This flexibility is available for both NPS Tier I and Tier II accounts, providing alternatives that align with the subscriber's life stage and desired asset allocation.


Conclusion:

The NPS investment options of Auto Choice and Active Choice cater to individuals with different investment preferences. Auto Choice appeals to passive investors, offering a life-cycle-based allocation strategy that adjusts the asset mix as retirement approaches. Active Choice provides greater control over asset allocation but entails higher investment risks. The flexibility to switch


investment options and fund managers further empowers NPS subscribers to align their investments with their changing needs. By understanding the features, asset classes, and allocation strategies of both options, subscribers can make informed decisions and embark on a journey towards building a secure retirement corpus with the NPS.

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