As the government plans to extend NPS to everyone, the onus is on the contributor to make the right investment choice.
Retirement planning, across the world, focuses on the pension amount that a person would be able to garner in his sunset years. A lot of countries have safety nets to make life easier for the older generation. In India, however, we are still struggling to create an efficient system to achieve this goal.
In recent years, the government has been playing a proactive role towards developing the area of pension. This has led to the introduction of the New Pension Scheme (NPS) for government employees. And now there are also hopes that in the next few months, there could be more improvement in these areas to help even the self-employed to get access to NPS. For the ones who are waiting for these new developments, here are a few things to note.
OPEN FOR ALL
At present, NPS is open only to government employees, who have joined after a specific date. This restricts the introduction of a larger number of people from investing in the scheme. With the proposal to include all under this scheme, more investors can look upon this as an option. The option for self-employed today is to buy a pension policy/annuity plan offered by insurance companies or invest in one of the two pension schemes offered by mutual funds.
When NPS opens up, it would become necessary for the investor to understand the new guidelines. This would be a voluntary route.
For ones, who wish to enter this scheme, there would be lots of decision-making involved in this process. That is, the kind of option that they are comfortable with such as, the aggressive or defensive methods of investing. Also, this scheme would be ideal for people who have more than 15 years to go for retirement as they can effectively build a retirement corpus.
PRIVATE FUND MANAGERS
For all these years, the task before investors with regards to any of their retirement savings was quite simple. All that they had to do was select the option that was suitable. Then sit back and watch the performance. In most cases, the return was fixed so there was little to worry about. Even in other circumstances, the problem of ensuring returns and performance was with the entity with whom the money was entrusted.
In NPS, there will be private fund managers to manage the money and the returns they generate will determine the amount that the investor gets as pension. For investors, it is important that they track the performance of fund managers because, they may have to select the one, who should be managing their money at a later date.
As far as existing pension plans and mutual funds go, the final corpus cannot be known because it is dependent on the performance of the scheme in the long run.
CHOICE OF INVESTMENTS
With the entry of NPS, investors will be forced to make a decision regarding their choice of investment style. So depending on the age, risk profile and the targeted corpus, the right kind of asset allocation will have to be made. The onus will be on them to make sure that the portfolio is constructed properly to suit their needs.
It is likely that the scheme will have provisions for various investment options, which will include, a fully safe option – where all the money is parked in debt instrument to an aggressive one – where a large part of the portfolio is in equities. There could other options where the portfolios are balanced, rather than skewed towards pure aggression or safety.
The corollary is that the safe option will be best suited for people who are closer to their retirement because a small change in the returns can significantly affect the end result. For example, a sum of Rs 1 lakh will become Rs 3.20 lakh at the end of 20 years at an annual rate of return of 6 per cent. At 8 per cent, the same amount becomes Rs 4.66 lakh.
Similarly, a sum of Rs 60,000 invested each year for 20 years at 6 per cent leads to an end corpus of Rs 25.43 lakh at the end of 20 years. The same Rs 60,000 at 8 per cent will become Rs 32.67 lakh after 20 years. However, in the latter option, while there are chances of higher returns, the risk is significantly higher as well. Another important point is that once a certain investment option has been chosen, changes have to be made during the tenure.
This is because while at the age of 25 or 30, the aggressive option might suit your investment style, but as you approach retirement, you may be have to opt for a defensive approach. This would imply reduction in equity exposure. In fact, even during the interim phase, choices will need to be made depending upon the outlook that you have of the market scenario. This will require constant monitoring as well as an eye on the changes required. Moving to NPS would put the onus on investors now. This is unlike the earlier years when they neither had the responsibility nor the option to take a call on the returns that their money would generate.
The writer is a certified financial planner
