NPS vs Mutual Funds

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  • 15 Sep 2023

Investing is crucial to financial planning and often involves choosing between various avenues. Two popular investment options in India are the National Pension System (NPS) and mutual funds. Both have their unique features and advantages.

NPS, short for the National Pension Scheme, is a social security initiative crafted by the Indian government. It extends its reach to virtually all working Indian citizens, including those in the public and private sectors and individuals in the unorganized labor force.

Previously, NPS was exclusively available to central government employees. However, the government has since expanded its accessibility to encompass any employed Indian citizen.

1. Voluntary Participation: NPS is open to all Indian citizens, including salaried and self-employed individuals. It is available to individuals aged 18 up to 60 years.

2. Choice of Investment: NPS allows investors to choose between different investment options based on risk tolerance. These options include equity (E), corporate bonds (C), and government securities (G). Investors can also opt for an "Auto Choice" option where the allocation is automatically adjusted based on their age.

3. Tiered Structure: NPS has a two-tiered structure:

  • Tier I Account: This is the primary retirement account with certain withdrawal restrictions. Contributions to Tier I are eligible for tax benefits under Section 80C, and there is a lock-in period until the age of 60.
  • Tier II Account: This voluntary savings account offers more liquidity. Tier II has no lock-in period, allowing investors to withdraw money whenever they want.

4. Flexible Contribution: Investors can contribute regularly or periodically to their NPS accounts. There is no fixed contribution requirement, making it flexible for individuals with varying income levels.

5. Annuity Options: Upon reaching 60, investors must use at least 40% of the accumulated corpus to buy an annuity from an Insurance Regulatory and Development Authority (IRDA)-regulated insurance company. This annuity provides a regular income stream during retirement.

6. Regulation: The NPS is regulated by the PFRDA, which oversees the functioning of various Pension Fund Managers (PFMs) and ensures compliance with regulations.

7. Online Access: NPS provides online access to account information, allowing investors to monitor their contributions and account balances easily.

8. Exit Options: At retirement, investors have multiple options, including purchasing an annuity, taking a lump-sum withdrawal (subject to certain conditions), or a combination of both.

NPS brings several benefits to the table. Some of them are as follows:

  • NPS encourages regular, disciplined savings by requiring investors to contribute regularly until retirement age. This helps individuals build a significant corpus over time.

  • NPS offers flexibility in choosing between different investment options based on risk tolerance, including equity (E), corporate bonds (C), and government securities (G). Investors can also opt for an "Auto Choice" option that adjusts the allocation based on their age.

  • Professional fund managers manage NPS investments who make investment decisions based on market conditions and investment objectives. This expertise can potentially lead to better returns.

  • NPS is specifically designed for retirement planning, ensuring that individuals have a financial cushion during their retirement years.

  • NPS is known for its relatively low-cost structure, with competitive management fees and charges compared to many other investment options.

  • NPS allows investors to contribute as per their financial capacity, making it accessible to various individuals with varying income levels.

  • With the compounding effect over an extended investment horizon, NPS can help individuals accumulate a significant retirement corpus, providing financial security in retirement.

Mutual funds invest in various stocks, bonds, or other securities. Professional fund managers or investment companies manage these funds, and they offer a way for individuals to invest in a diversified portfolio without having to buy and manage individual securities directly.

Here are some of the key features of mutual funds:

  1. Diversification: Mutual funds invest in various securities which helps spread risk. This diversification brings down the impact of poor performance in any single investment on the overall portfolio.

  2. Professional Management: Experienced fund managers make investment decisions on behalf of the investors. They conduct research, analyze market conditions, and choose securities to achieve the fund's objectives.

  3. Liquidity: Mutual fund units can typically be bought or sold on any business day at the fund's NAV. This provides investors with liquidity, allowing them to easily access their investments.

  4. Affordability: Mutual funds allow investors to participate in a diversified portfolio with relatively little money. This makes them accessible to a wide range of investors.

  5. Transparency: Mutual funds need to disclose their holdings and NAV regularly, ensuring transparency and allowing investors to track their investments' performance.

  6. Variety of Funds: Mutual funds come in various types to suit different investment goals and risk tolerance levels. These include equity funds, debt funds, hybrid funds, index funds, sector-specific funds, and more.

  7. Automatic Investment Options: Many mutual funds offer systematic investment plans (SIPs) and systematic withdrawal plans (SWPs) that allow investors to automate their investment and redemption processes.

  8. Tax Benefits: Some mutual fund schemes, such as Equity-Linked Savings Schemes (ELSS), offer tax benefits under Section 80C of the Income Tax Act in India.

  9. Flexibility: Investors can choose from different options regarding how they want to invest, such as growth or dividend reinvestment, and they can switch between funds within the same asset management company.

  10. Regulation: Mutual funds are regulated by government authorities or regulatory bodies, such as SEBI. This oversight ensures investor protection and compliance with investment guidelines.

Some of the major benefits of investing in mutual funds are as follows:

  • Professional fund managers manage mutual fund investments who have the expertise to make investment decisions on behalf of investors. These managers conduct research, analyze market conditions, and choose securities to achieve the fund's objectives.

  • Mutual funds allow investors to participate in a diversified portfolio with relatively little money. This makes them accessible to many investors, including those with limited capital.

  • Mutual funds come in various types to suit different investment goals and risk tolerance levels. These include equity funds, debt funds, hybrid funds, index funds, sector-specific funds, and more.

  • Investors can choose from different options for investing in mutual funds, such as growth or dividend reinvestment. They can also switch between funds within the same asset management company.

Following are the differences between the NPS and mutual funds on various parameters -

Parameters NPS Mutual Funds
Purpose
NPS is primarily designed for retirement planning and building a corpus for post-retirement income.
Mutual funds cater to various investment objectives, including wealth creation, income generation, and capital preservation, without a specific focus on retirement.
Investment options
NPS offers limited investment options, including equity (E), corporate bonds (C), and government securities (G), with allocation based on the investor's risk tolerance.
Mutual funds offer a range of investment options, including equity, debt, hybrid, thematic, and sector-specific funds, catering to different risk profiles and financial goals.
Lock-in period
NPS enforces a mandatory lock-in period until the investor reaches the age of 60, making it a long-term commitment.
Apart from ELSS funds, mutual funds do not have a mandatory lock-in period, offering more liquidity and flexibility.
Liquidity
NPS has limited liquidity options, and premature withdrawals are subject to certain conditions and penalties.
Mutual funds generally offer daily liquidity, allowing investors to redeem their investments at any time, though exit loads may apply if redeemed before a specified period.
Annuity requirement
Upon retirement, investors must use at least 40% of the accumulated NPS corpus to purchase an annuity, providing a regular income stream.
Mutual funds do not require investors to purchase annuities, providing more flexibility in utilizing the corpus during retirement.
Portability
NPS accounts are portable, allowing investors to continue their accounts even if they change jobs or locations.
Mutual fund investments can be easily transferred to another fund within the same asset management company but do not offer the same level of portability as NPS.
Risk exposure
The risk exposure in NPS depends on the choice of asset allocation (E, C, G). It can range from low risk (G) to high risk (E).
Risk exposure varies widely among mutual funds based on their investment objectives, ranging from conservative (debt funds) to aggressive (equity funds).

The choice between NPS and mutual funds depends on an individual's financial goals, risk tolerance, and investment horizon. NPS is geared towards long-term retirement planning with tax benefits, while mutual funds offer greater flexibility and a wider range of options for various financial objectives. Diversification and professional fund management are common features that can benefit investors in both NPS and mutual funds.

FAQs on NPS vs Mutual Fund

Both NPS and mutual funds are prudent investment avenues. While the NPS helps you build a retirement corpus, mutual funds allow you to accumulate funds for various short and long-term goals such as children’s higher education, emergency corpus, etc.

Yes, NPS is subject to market risks and past performance is no guarantee of the future.

NPS Tier 2 offers a cost-effective alternative compared to mutual funds. Its expense ratio remains below 0.09 percent, while 'direct' mutual funds typically carry expense ratios ranging from 0.3 to 1 percent. The expense ratio is even higher when considering 'regular' mutual funds.

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