Understanding Auto and Active Investment Choice in NPS. Which one should you go for?

Nischay Avichal

Retirement planning is an indispensable step for everyone, and the sooner it is planned, the merrier the outcome. Planning early will help you start small and get the maximum benefit of the all-good compounding. Planning your retirement the right way and accumulating a suitable corpus is vital, ultimately deciding your preparedness to retire comfortably.
When it comes to retirement, the two primary choices for most of the employed workforce are the Employee Provident Fund (EPF) and the National Pension System (NPS). Although the former is available only for the formally employed workforce, NPS is open to all Indian residents. Despite EPF being the superior choice for most people due to its guaranteed returns, NPS has also gained popularity due to its exclusive tax benefits and the flexibility to choose investment options. This is reflected in the near 27% YoY growth of NPS AUM and a 9.4% YoY increase in the number of NPS subscribers at the end of FY22.
Investment options
When you open an NPS account, you are required to choose a Pension Fund Manager (PFM) initially and one of the two investment options – Active or Passive- which is the focus of this blog. There are currently eight PFM to choose from:
  1. Aditya Birla Sunlife Pension Management Limited
  2. HDFC Pension Management Company Limited
  3. ICICI Prudential Pension Funds Management Company Limited
  4. Kotak Mahindra Pension Fund Limited
  5. LIC Pension Fund Limited
  6. Reliance Capital Pension Fund Limited
  7. SBI Pension Funds Private Limited
  8. UTI Retirement Solutions Limited
Active investment choice: In this option, you have the right to actively decide how your investments are allocated to different asset classes. Once you select the active option, you will have to choose the percentage allocation for each of the asset classes.
Under NPS, the four asset classes are – Asset class E, G, C, and A.
  • Asset Class E: Equity and related instruments. Even if a subscriber chooses the active option, the NPS has restrictions in place in regards to allocation to the equity class as per the age of the subscriber.
  • Asset Class G: Government Bonds and related instruments
  • Asset Class C: Corporate debt and related instruments
  • Asset Class A: This asset class includes instruments like CMBS (Commercial mortgage-backed securities), MBS (Mortgage-backed securities), REITs (Real estate investment trusts), AIFs (Alternative investment funds), and InVITs (Infrastructure Investment Trusts). The maximum an active subscriber can allocate under this asset class is 5%.
Auto investment choice: In this option, you can choose among three lifecycle funds which automatically adjust the asset allocation as you age. You need not select your asset allocation under this option, and the same is decided by a pre-defined portfolio. The auto choice option automatically reduces exposure to risky investment options as you age by reducing exposure to asset classes like equity and corporate Debt.
The lifecycle funds are categorised based on risk – Aggressive life cycle fund (LC75), Moderate life cycle fund (LC50), and Conservative life cycle fund (LC25).
Below is a rough breakup of asset allocation under the three auto options across an NPS subscriber’s age. You would notice how the allocation to debt class (especially towards government securities) increases as the age increases, i.e., as the subscriber nears retirement.
The ultimate choice
The auto choice is a good starting point for individuals with no expertise in investment management or who are yet to gain knowledge of the financial markets and have little confidence in managing and making asset allocation decisions in their portfolios. The Moderate life cycle fund (LC50) is the default option under the auto choice. If you can take higher risks with your investments– which depends on your risk profile and years to retirement– you can go with the LC75 under auto choice.
An individual must consider active choice if:
  • They are actively seeking investment advice from a professional
  • They have a high-risk appetite.
  • They are familiar with financial markets and confident in managing their investments.
  • They want more flexibility in managing their asset allocation.
What did you choose? Please leave your comments to let us know, and thank you for taking the time to read.
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