Choose the right asset allocation to make the most of your NPS investments

• When choosing the right asset allocation for NPS investments, one should consider factors such as risk tolerance, investment goals and time horizon.
  
• Knowledgeable and disciplined investors can select the active option and benefit from the flexibility of allocation.
  
• One should consider the overall portfolio when deciding on the asset allocation under NPS.
  

Investors participating in the National Pension System (NPS) have the opportunity to allocate their investments among various asset classes, namely equity, corporate debt, government securities, and alternative investment funds. Each of these asset classes has the potential to generate returns, but they also carry different levels of risk.

“When choosing the right asset allocation for NPS investments, one should consider factors such as risk tolerance, investment goals, and time horizon,” says Satyen Kothari, founder and chief executive officer of Cube Wealth, a financial planning and advisory platform.

Active choice vs auto choice

NPS offers two investment choices- auto choice and active choice. Auto choice is based on your age and the allocation within different asset classes will change as your age increases. Active choice is where you have the liberty to decide your allocation throughout the tenure of your investment. “The thought process here is that as your age increases, your ability to take risks reduces and hence the money from equity will move into non-equity options,” says Harshad Chetanwala, co-founder MyWealthGrowth.Com, an investment planning firm.

“The auto choice could be good for someone who does not want to get into the hassles of changing and managing their allocation based on age, tenure and other criteria. Those who are clear with the kind of allocation they need can go for active choice. Active has the benefit over auto as you are in better control of your allocation when you see from an overall portfolio perspective,” says Chetanwala.

Agrees Rahul Jain, president and head, Nuvama Wealth, “Knowledgeable and disciplined investors can select the active option and benefit from the flexibility of allocation. Those who are short on time or need help to keep up with the lifecycle change can choose the auto choice.”

Lifecycle-based asset allocation

Lifecycle-based allocation is available under auto choice. It adjusts the investment mix based on an individual's age. “It starts with a higher allocation to equities when young and gradually shifts towards debt instruments as retirement approaches. This strategy aligns with a person's changing risk appetite and aims to optimise returns while managing risk, providing individuals with a systematic approach to planning for retirement,” says Kothari.

The investor can choose between three lifecycle funds: Aggressive Lifecycle Fund (LC75), Moderate Lifecycle Fund (LC50), and Conservative Lifecycle Fund (LC25). “Within each option, the equity allocation decreases by a specified percentage every year while the debt allocation increases,” says Jain.

Let us take the example of LC75. Under this fund, the investor can get up to 75% allocation to equity till the age of 35 years. Beyond 35 years, the equity allocation decreases by 4% every year till 45 years, by 3% till 50 years and by 1% till 55 years. At the same time, allocation to government securities increases by 3% every year till 55 years. The rest gets allocated among the corporate bonds every year.

Consider overall portfolio when deciding on NPS asset allocation

“When considering NPS asset allocation along with other investments like mutual fund SIPs, Public Provident Fund (PPF), FDs, etc., it is crucial to assess the overall portfolio and align it with one's financial goals and risk tolerance. The asset allocation should be diversified across different investment avenues, taking into account the risk-return characteristics of each,” says Kothari.

So far NPS is not a huge part of investors' overall portfolio and the same could remain even when their portfolio grows in future. “Hence, one should consider all the assets at the time of deciding on the asset allocation of NPS. If someone is already investing in PPF or Voluntary Provident Fund (VPF), then you are already accumulating debt for your retirement,” says Chetanwala. In such a case, going for a higher debt allocation may not be the best option.

NPS asset allocation lets individuals strategically allocate their investments across various asset classes, offering the potential for returns and managing risk. With careful consideration of their financial goals, risk tolerance, and time horizon, one can create a well-balanced portfolio within NPS.