TheNational Pension System (NPS)has emerged as a popular choice among Indians seeking to secure their financial future post-retirement. In part, this popularity is due to the tax-saving benefits in NPS. Another reason for this popularity is because of the flexibility it offers in terms of how your money gets invested.
NPS not only gives you the option of multiple asset classes (Equities, Corporate Debt, Government Bonds, and Alternative Investment Funds), it also lets you decide what proportion of investments are to be allocated towards each asset class. While having choices when investing is definitely beneficial, it is easy to get confused when faced with so many choices.
In this blog, we will discuss key aspects of NPS including the different types of NPS investment options, how the Active Choice and Auto Choice options of NPS work, and tips to help you choose the ideal NPS Asset Allocation for your portfolio.
Different Asset Classes Available for Your NPS Investments
ECGA in NPS are the four primary asset classes in which NPS subscribers can invest their savings. E indicates Equities, C is Corporate Debt, G is Government Bonds, and A is Alternative Investment Funds. Each asset class represents different types of financial instruments and investment opportunities:
Equities (E)
The money is invested in the stocks and other equity-related instruments of companies listed in India. Equity investments carry a higher level of risk but also have the potential for higher returns over the long term.
Corporate Debt (C)
The money allocated is primarily invested in Money Market Instruments and Bonds issued by various Corporations including Infrastructure Companies, PSUs (Public Sector Units), and PFIs (Public Financial Institutions), Infrastructure Companies, and Money Market Instruments. Corporate debt investments typically offer lower risk compared to equities, with relatively stable returns.
Government Securities (G)
In this asset class, investments are made in securities issued by the Central Government, State Governments, and Money Market Instruments. Government bonds are considered safer than corporate debt and equities, making them suitable for conservative investors seeking stable returns.
Alternative Investment Funds (A)
This asset class includes investments in various alternative instruments like Commercial Mortgage-Backed Securities (CMBS), Real Estate Investment Trusts (REITs), Infrastructure Investment Trusts (InvITs), and other Alternative Investment Funds. Alternative investments offer diversification benefits and potential for unique returns compared to traditional asset classes.
Choosing Your NPS Investment’s Asset Allocation
As we mentioned earlier, apart from giving you the option of multiple asset classes, NPS also gives you the flexibility to decide how much gets invested in each of these asset classes.
Since each of these asset classes has a different risk-return profile, this flexibility allows you to customize your NPS asset allocation and have it in sync with your risk profile.
Currently, NPS offers you two options to choose the asset allocation for your NPS portfolio –Active Choice and Auto Choice.
Let’s look at both these options in detail.
1. Active Choice
The Active Choice option of NPS offers you the highest flexibility in selecting the proportion of Equity, Corporate Debt, Government Securities, and Alternative Investment Funds in your portfolio. There are, however, some restrictions regarding how much you can allocate towards individual investment options:
- Maximum allocation permitted towards Alternative Investment Funds (AIFs) is 5%
- Maximum Equity exposure permitted in NPS is 75%
You should keep in mind that these are the maximum permissible limits of Equity allocation under NPS Active Choice. You can choose a lower Equity allocation for your NPS portfolio irrespective of your age as part of your overall investment strategy.
The key benefit of Active Choice is the freedom you get in choosing the NPS asset allocation that you think is most suitable to reach your investment goals. Additionally, the NPS Active Choice option automatically reduces your NPS portfolio’s allocation to Equities as you get closer to retirement and increases the proportion of Debt investments to help contain the potential volatility in your portfolio.
2. Auto Choice
The second option allows you to automate your NPS asset allocation. Auto Choice works on the principle that as you grow older and get closer to retirement, your focus should be on wealth preservation by minimizing the overall portfolio risk. It achieves this by modifying your NPS asset allocation as per your age.
However, within auto choice too you get some flexibility. In NPS Auto Choice, you have 3 different asset allocation models. These are called Life Cycle Funds and differ from each other on how much is allocated to each asset class and how changes are made as per your age.
- Aggressive Life Cycle Fund (LC75)
With Aggressive Life Cycle Fund, you get equity exposure of up to 75% till the age of 35 years. From your 36th year onwards, the NPS Equity allocation is decreased by 4% every year, and that money is moved to Corporate Debt and Government Securities. Additionally, fresh investments to NPS will also be distributed across Equities, Corporate Debt, and Government Securities as per the age-based allocation specified by LC75.If you invest in the LC75 NPS Auto Choice option, your investments across various asset classes will change like this:
| Asset Allocation under NPS Auto Choice for Aggressive Life Cycle Fund Investor | |||
| Age | Equity Allocation | Corporate Debt Allocation | Government Securities Allocation |
| Up to 35 years | 75% | 10% | 15% |
| 40 years | 55% | 15% | 30% |
| 45 years | 35% | 20% | 45% |
| 50 years | 20% | 20% | 60% |
| 55 years and above | 15% | 10% | 75% |
LC75 offers high Equity exposure of up to 75% which can help you aggressively grow your Retirement Savings when you are in your early 30s. Then, the automatic shift of yourNational Pension Systemportfolio towards Government Securities and Corporate Debt as you grow older helps reduce the short-term volatility in your NPS account and ensures wealth preservation to secure your financial future post-retirement.
- Moderate Life Cycle Fund (LC50)
Also known as LC50, this is the default option under the NPS Auto Choice option. If you select the Moderate Life Cycle Fund, your maximum Equity exposure will be 50% up to the age of 35 years. From your 36th year onwards, your NPS asset allocation towards Equities will decrease by 2% every year and get reinvested into Corporate Debt and Government Securities. New contributions into NPS will also be allocated to different NPS investments as per the allocation specified under LC50.
The below table shows how NPS portfolio allocation across Equities, Corporate Debt, and Government Securities will change with your age if you opt for the Moderate Life Cycle Fund:
| Asset Allocation under NPS Auto Choice for Moderate Life Cycle Fund Investor | |||
| Age | Equity Allocation | Corporate Debt Allocation | Government Securities Allocation |
| Up to 35 years | 50% | 30% | 20% |
| 40 years | 40% | 25% | 35% |
| 45 years | 30% | 20% | 50% |
| 50 years | 20% | 15% | 65% |
| 55 years and above | 10% | 10% | 80% |
The Moderate Life Cycle Fund aims to provide an NPS Equity allocation that offers an optimal balance between capital appreciation and wealth preservation.
- Conservative Life Cycle Fund (LC25)
LC25 option is the most cautious of all the options available. The Conservative Life Cycle Fund limits your NPS Equity allocation to a maximum of 25% till the age of 35 years. When you turn 36 years of age, the NPS portfolio allocation towards Equities will decrease by 1% every year which gets reinvested in Corporate Debt and Government Securities. The allocation across different asset classes for investors in different age groups opting for the LC25 Conservative Life Cycle Fund will be something like this:
| Asset Allocation under NPS Auto Choice using Conservative Life Cycle Fund | |||
| Age | Equity Allocation | Corporate Debt Allocation | Government Securities Allocation |
| Up to 35 years | 25% | 45% | 30% |
| 40 years | 20% | 35% | 45% |
| 45 years | 15% | 25% | 60% |
| 50 years | 10% | 15% | 75% |
| 55 years and above | 5% | 5% | 90% |
By limiting NPS portfolio allocation towards Equities, the Conservative Life Cycle Fund focuses on wealth preservation and limits short-term portfolio volatility. As a result, the LC25 investment option is ideally suited to the needs of NPS subscribers who have low-risk tolerance.
Also Read:Should You Invest in NPS?
Picking Your Asset Allocation: Go for LC75 if you are in your 30s
The Aggressive Life Cycle Fund or LC75 allows you to allocate up to 75% of your NPS investments in Equities up to the age of 35 years. Among all NPS Tier 1 investment options, Equities offer the highest long-term growth potential even though they are prone to short-term volatility.
When you are in your 30s, your retirement is at least 20-25 years away so it makes sense to consider your NPS Account as a long-term investment option for retirement planning. Thus, among the 3 Life Cycle Fund options offered under NPS Auto Choice, LC75 gives you the best chance to aggressively grow your NPS Retirement Savings in the long term.
Moreover, as you get closer to retirement, LC75 will automatically readjust your NPS asset allocation to focus on wealth preservation by increasing the proportion of Debt investments that can cushion the impact of short-term volatility from your Equity investments. So, unless you are a conservative saver, LC75 is the ideal NPS Auto Choice Life Cycle Fund investment option when you are in your 30s.
You can use NPS Calculator to Calculate your returns based on asset allocations and Investment Strategy.
Bottom Line
The National Pension System is a long-term investment and its primary goal is to ensure your financial security post-retirement. The goal ofAsset Allocationis to help you design an investment portfolio that minimizes risk and maximizes NPS returns. Thus choosing the correct NPS Asset Allocation can potentially help you balance wealth creation and wealth preservation so that you can retire without any worries regarding your financial well-being during your golden years.
FAQs
Can I change my asset allocation in NPS over time?
Yes, you can change your asset allocation in the NPS account. As per the recent update by PFRDA, subscribers can change their asset allocation four times a year; previously, it was two in a financial year.
How do I determine the right asset allocation for my NPS investments?
The right allocation in NPS depends on your risk tolerance and investment objective. NPS offers you two options of asset allocation: Auto choice and Active choice. If you do not want to adjust your asset allocation manually, auto-choice is best for you as it will automatically update your asset allocation based on your age and risk profile.
However, if you want to choose your asset allocation by yourself, then you can select the active choice.
Are there any restrictions on asset allocation in NPS?
Yes, there are restrictions on the asset allocation in NPS.
For the Active Choice Option, maximum exposure to equity is capped at 75%, and for Alternative Investment Funds (AIFs), it is 5%
For the Auto choice option, the restriction to asset allocation varies on the selected asset model:
Aggressive Life Cycle Fund: Maximum equity exposure to equity capped at 75% upto 35 years of age. Thereby reducing by 4% every year.
Moderate Life Cycle Fund: Maximum equity exposure to equity capped at 50% upto 35 years of age. Thereby reducing by 2% every year.
Conservative Life Cycle Fund: Maximum equity exposure to equity capped at 75% upto 25 years of age. Thereby reducing by 1% every year.
What is Scheme E and Scheme G in NPS?
Under NPS, Scheme E refers to the investments in the equity market instruments. Scheme G refers to the investments in Government securities.
How does the allocation of E, C, and G change under the Auto Choice option?
Under the auto choice option, the allocation to E, C and G is determined based on the subscriber’s age. At each birth anniversary, the proportions of these asset classes are adjusted as per age.
How frequently can a Subscriber change their scheme preference?
As per the new guidelines by PFRDA, the subscriber can change their scheme preference four times a year.
