NPS investor? Don't make this mistake

When investing in the National Pension System (NPS), you're presented with two options: Auto choice and Active choice.

On the surface, Auto choice feels like the simpler, more convenient option. It automatically handles asset allocation for you, adjusting your investments between equity, corporate bonds and government securities based on your age.

This hands-free approach often tempts investors into choosing it. After all, who wouldn't want an "expert" system managing their money?

But here's the catch—this default choice could be silently restricting your long-term returns.

Understanding Auto choice

The Auto choice in NPS offers four variants, each with varying levels of equity exposure designed for different risk preferences. While they differ slightly, all four follow a common pattern.

• Conservative life cycle fund (LC25) - Starts with just 25 per cent equity and begins tapering every year from the age of 35, reaching a mere 5 per cent by the time you hit 55.
  
• Moderate life cycle fund (LC50) (the default option) - Begins with 50 per cent equity but also starts reducing every year from 35, reaching 10 per cent by age 55.
  
• Balanced life cycle fund (BLC50) - A recent addition that starts with 50 per cent equity, but the tapering begins later at 45, dropping to 35 per cent by the age of 55.
  
• Aggressive life cycle fund (LC75) - Starts with the highest equity exposure of 75 per cent, but like the others, it begins reducing at 35 and shrinks to 15 per cent by the age of 55.

Even the most aggressive plan turns conservative too soon

At first glance, the Aggressive life cycle fund (LC75) seems like a growth-oriented choice with its 75 per cent equity allocation. However, the automatic reduction of equity exposure starts as early as 35, when most investors still have decades left to retire.
By the time you turn 55, your equity allocation drops to just 15 per cent, with the majority shifted into bonds and government securities.

The issue? Equity has historically outperformed other asset classes over the long term. Cutting it down too early may reduce short-term volatility but, more importantly, caps your growth potential during prime wealth-building years.

If you want your NPS investments to work harder, staying invested in equity for longer can make a substantial difference to your retirement corpus.

Why Active choice could be a smarter move

So, if you are serious about maximising your NPS returns, Active choice offers greater flexibility and long-term growth potential compared to Auto choice.

It allows you to allocate up to 75 per cent in equity and maintain that level, without the automatic reduction that occurs with Auto choice.

You also have complete control over how your contributions are distributed among equity, corporate bond, and government securities, enabling you to align your portfolio with your personal risk appetite and financial goals.

For younger investors with a long investment horizon, maintaining a higher equity exposure can be particularly advantageous, as it allows more time for compounding to work, potentially leading to significantly higher long-term returns.

What difference can it make?

To understand the impact of equity tapering, let's compare returns over the last decade:

• NPS equity funds: Delivered 12.5 per cent annualised returns
  
• Government securities: Returned 8.5 per cent annually

That's a difference of over 40 per cent. A Rs 10 lakh investment in equity a decade ago would have grown to around Rs 32.4 lakh, while the same investment in government securities would be worth just Rs 22.6 lakh.

This difference compounds significantly over longer periods, making a strong case for maintaining a higher equity allocation through Active choice.

How to check which investment choice you are using

To check your investment choice, simply log into your NPS account and access your holdings statement. It clearly mentions whether you have chosen Active choice or Auto choice, along with the specific investment option selected.

How to switch from auto to active choice

If you're in Auto choice and want to switch to Active choice, the process is simple and can be done four times per financial year for free.

Steps to switch:

1. Log in to your NPS account through the official portal

2. Go to Change scheme preference

3. Select Active choice as your investment preference

4. Set your desired asset allocation (up to 75 per cent equity)

5. Confirm the changes and you're done!

The last word

While Auto choice seems convenient, its automatic equity tapering could be costing you valuable growth potential, especially when you have time on your side.

If you want to maximise your retirement corpus, consider checking your investment choice today.

Switching to Active choice with higher equity allocation could be a game-changing move for your financial future.

Also read: Should you invest in NPS Vatsalya?

This article was originally published on January 13, 2025.