To Invest In NPS Or Mutual Funds – That Is The Question

Retirement planning is an extremely important aspect of one's life. Done carefully, it ensures a life of comfort after one retires. It is important to invest in instruments that can deliver inflation-beating returns so that one can meet his post-retirement expenses easily. The National Pension Scheme (NPS) and mutual funds are two of the most popular investing avenues. 

The National Pension Scheme (NPS) was launched by the Government of India as a social security initiative. Under this scheme, an individual allocates a certain amount from his income towards his pension account. When the individual retires, he can withdraw part of the corpus, and the balance amount is credited to his account every month. The scheme has been highly popular among individual investors due to high safety it offers. 

The NPS has several benefits. For one, contribution is voluntary. An individual has the flexibility to increase or decrease his contribution on an annual basis. Secondly, only 50 per cent of the corpus is invested in equity, which contains the risk of volatility. Since NPS is regulated by the Pension Fund Regulatory and Development Authority (PFRDA), there is complete transparency in the administration. 

Mutual funds, on the other hand, are professionally managed schemes which invest in multiple investments. Both NPS and mutual funds are eligible for tax deductions under Section 80C of the IT Act, 1961. Both have a lock-in period; however, mutual funds have an advantage here. The lock-in period of ELSS funds is three years while NPS allows withdrawal only after the individual has attained 60 years of age or at the time of retirement. NPS has strict rules for premature withdrawals. A person can only withdraw 25 per cent of his corpus, and the limit to such withdrawals is 3 times during the scheme tenure. Mutual funds, on the other hand, do not have such restrictions. A person can withdraw the entire amount after the lock-in period of three years.

When it comes to tax benefits NPS has a slight edge. Aside from tax benefits up to Rs 1.50 lakh of the gross income under Section 80CCE of the IT Act, the NPS subscriber can claim additional tax benefit of Rs. 50,000 under subsection 80CCD (1B) of the Income Tax Act, 1961. On taxability front, NPS is tax free to the extent of 60 per cent of the corpus while the remaining 40 per cent is taxable as per the applicable tax slab of the individual.

When it comes to returns, mutual funds score over NPS. NPS typically offers annual returns up to 8 per cent - 10 per cent which is higher than other fixed income instruments. However, mutual funds, in the long run, have generated above average returns between 15 per cent -17 per cent annually. If the investor starts early and invests through SIP, he will be able to amass a greater corpus in the long run. The SIP route also protects the investor's capital from volatility. 

Why SIP scores over NPS?

Systematic Investment Plan (SIP) has become most preferred form of Investment among the investors. SIPs instil a sense of financial discipline among the investors. SIP allows the investor to take advantage of the power of compounding thus translating into the higher returns in the long term. While Investing through SIP the investor need not worry about volatility as it allows the benefit of rupee cost averaging. When markets experience volatility the investor cost average his investments thus lowering his investment cost. 

Historically equity funds have delivered above average returns in the long term. For example, if an investor invests just Rs 5000 every month through SIP in equity funds then he can amass the corpus of Rs 74 lac in 20 years at 15 per cent return per annum. The more the investment the greater the returns. If one is afraid of volatility one can allocate minimum 15 per cent – 20 per cent of his capital in mutual funds. 

Whether NPS or mutual fund, each one has distinct advantages. Ideally an investor must invest in both. This ensures that the investments are balanced. While NPS ensures stability and security the mutual fund investments ensure growth of capital. Even conservative investors can adopt the balanced investment strategy and reap rewards of capital growth. Aggressive investors can allocate more capital towards mutual fund while moderately Investing in NPS. 

It is highly advisable to consult the qualified financial planner before investing in mutual funds. Remember mutual funds are subject to market risk. Before investing in mutual funds, it is important to assess one's risk tolerance and invest in the right fund. A good financial advisor understands the intricacies of the vast mutual fund universe and he will be able to guide in making better investment decisions. 

The author is Founder, Investonline.in

DISCLAIMER: Views expressed are the author's own, and Outlook Money does not necessarily subscribe to them. Outlook Money shall not be responsible for any damage caused to any person/organisation directly or indirectly.