NPS - Should you invest?

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The Pension Fund Regulatory and Development Authority (PFRDA) declared the annual weighted average returns (see graphics) for the National Pension System (NPS) investment funds on May 15. Although, the returns look impressive but when you are looking at a long-term product, you can't set much store with just one indicator of annual return. You need to understand the product fully and your commitment towards it.

A look at the returns

Since most pension fund managers track Nifty, we looked at the returns of the Nifty index for FY13. Nifty returned 6.05% in FY13. "Nifty return doesn't take into account the dividend yield which index funds factor in their return calculation. Dividend yields can make a difference of about 1.5-2 percentage points. So if the returns are more than Nifty by that margin, it means the funds have returned close to the Nifty returns," said Manoj Nagpal, CEO, Outlook Asia Capital, a wealth management firm.

For an investor, the maximum exposure to equity is capped at 50% but for the other two schemes - government and corporate debt - you can invest up to 100% of your money. However, there isn't a benchmark that can be strictly comparable. Mukesh Jindal, partner, Alpha Capital, a financial planning firm based in Gurgaon attempts a comparison. "If you look at the Crisil 10-year Gilt Index, for FY13 it has returned 11.25%. Even other mutual funds that invest purely in government securities have returned in the range of 12.54-14.89%. Looking at these numbers, the NPS government scheme has outperformed most of the other comparable schemes," he said.

Even the corporate debt scheme looks like an outperformer. "If you compare the corporate debt scheme to Crisil Composite Bond Fund Index, NPS scheme has outperformed by a huge margin. Crisil Bond Index Fund returned 9.24% compared with 14.19% of the NPS scheme. Other comparable mutual funds have returned in the range of 11.12-12.62%," said Jindal.

Understand the product

The one-year return definitely looks impressive but it's not enough to take a decision. NPS is still in its infancy stage and need to be understood well. An investor needs to look at diversification, risk appetite, liquidity and tax issues.

Lock-in: Since it is aimed at targeted savings, it locks in your investments till 60 years of age. If you wish to withdraw it before you turn 60, you will have to annuitise at least 80% of your money. Annuity is a pension product that gives you a periodic income for life. At 60 you can withdraw 60% of the money as lump sum. The remaining 40% needs to be annuitised.

Returns are market linked: Even as the returns are impressive these are not the final returns. That's because this is a market-linked product and the returns are not guaranteed. But if you take Public Provident Fund or Employees' Provident Fund, if you are a salaried individual, the return on your investment is guaranteed once declared. NPS is taxable: The amount you contribute qualifies for a tax deduction of R1 lakh subject to a maximum of R1 lakh under the overall section of 80C of the Income-tax Act. On maturity, the 60% of the corpus that you can have as lump sum is taxable.

What should you do?

NPS is not meant for equity investors since the scheme caps equity investment at 50%. But even for an investor who is looking to balance her portfolio with a limited exposure to equity, there have been certain changes in NPS that needs a mention. Unlike the original idea of investing in equities through index funds, PFRDA has allowed pension fund managers to invest directly in stocks, although with guidelines to ensure investments in large and liquid stocks and caps to mitigate concentration risks. This has made investments in equities riskier as it has introduced the risk of the fund manager's choice.

But if you want to invest in debt schemes, then you should first maximise your EPF and PPF. The scheme offers no liquidity and makes it mandatory to annuitise a part of the corpus on maturity. Investors looking to save for retirement should first invest in guaranteed products such as EPF and PPF before looking at NPS

Have a proper asset allocation and maximise your debt savings first with PPF and EPF before you look at NPS.

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